[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2011 Edition]
[From the U.S. Government Printing Office]



[[Page 1]]

          
          
Title 26

Internal Revenue


________________________

Parts 50 to 299

                         Revised as of April 1, 2011

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2011
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as a 
                    Special Edition of the Federal Register

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                            Table of Contents



                                                                    Page
  Explanation.................................................       v

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Finding Aids:
      Table of CFR Titles and Chapters........................     567
      Alphabetical List of Agencies Appearing in the CFR......     587
      Table of OMB Control Numbers............................     597
      List of CFR Sections Affected...........................     615

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                     ----------------------------

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 50.1 refers 
                       to title 26, part 50, 
                       section 1.

                     ----------------------------

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                               EXPLANATION

    The Code of Federal Regulations is a codification of the general and 
permanent rules published in the Federal Register by the Executive 
departments and agencies of the Federal Government. The Code is divided 
into 50 titles which represent broad areas subject to Federal 
regulation. Each title is divided into chapters which usually bear the 
name of the issuing agency. Each chapter is further subdivided into 
parts covering specific regulatory areas.
    Each volume of the Code is revised at least once each calendar year 
and issued on a quarterly basis approximately as follows:

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1

    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

    The contents of the Federal Register are required to be judicially 
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie 
evidence of the text of the original documents (44 U.S.C. 1510).

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
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    To determine whether a Code volume has been amended since its 
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Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

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citations for the regulations are referred to by volume number and page 
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inserted following the text.

OMB CONTROL NUMBERS

    The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires 
Federal agencies to display an OMB control number with their information 
collection request.

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
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OBSOLETE PROVISIONS

    Provisions that become obsolete before the revision date stated on 
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``[RESERVED]'' TERMINOLOGY

    The term ``[Reserved]'' is used as a place holder within the Code of 
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the requirements of 1 CFR part 51 are met. Some of the elements on which 
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    (b) The matter incorporated is in fact available to the extent 
necessary to afford fairness and uniformity in the administrative 
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    An index to the text of ``Title 3--The President'' is carried within 
that volume.

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the revision dates of the 50 CFR titles.

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    Director,
    Office of the Federal Register.
    April 1, 2011.







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                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty volumes. The 
contents of these volumes represent all current regulations issued by 
the Internal Revenue Service, Department of the Treasury, as of April 1, 
2011. The first thirteen volumes comprise part 1 (Subchapter A--Income 
Tax) and are arranged by sections as follows: Sec. Sec.  1.0-1.60; 
Sec. Sec.  1.61-1.169; Sec. Sec.  1.170-1.300; Sec. Sec.  1.301-1.400; 
Sec. Sec.  1.401-1.440; Sec. Sec.  1.441-1.500; Sec. Sec.  1.501-1.640; 
Sec. Sec.  1.641-1.850; Sec. Sec.  1.851-1.907; Sec. Sec.  1.908-1.1000; 
Sec. Sec.  1.1001-1.1400; Sec. Sec.  1.1401-1.1550; and Sec.  1.1551 to 
end of part 1. The fourteenth volume containing parts 2-29, includes the 
remainder of subchapter A and all of Subchapter B--Estate and Gift 
Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49; 
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499 
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter 
G--Regulations under Tax Conventions); and part 600 to end (Subchapter 
H--Internal Revenue Practice).

    The OMB control numbers for Title 26 appear in Sec.  602.101 of this 
chapter. For the convenience of the user, Sec.  602.101 appears in the 
Finding Aids section of the volumes containing parts 1 to 599.

    For this volume, Cheryl E. Sirofchuck was Chief Editor. The Code of 
Federal Regulations publication program is under the direction of 
Michael L. White, assisted by Ann Worley.

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE




                  (This book contains parts 50 to 299)

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                                                                    Part

chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................          50

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    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)




  --------------------------------------------------------------------


  Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980, 
deleting statutory sections from their regulations. In Chapter I cross 
references to the deleted material have been changed to the 
corresponding sections of the IRS Code of 1954 or to the appropriate 
regulations sections. When either such change produced a redundancy, the 
cross reference has been deleted. For further explanation, see 45 FR 
20795, March 31, 1980.

          SUBCHAPTER D--MISCELLANEOUS EXCISE TAXES (CONTINUED)
Part                                                                Page
50              Regulations relating to the tax imposed with 
                    respect to certain hydraulic mining.....           5
52              Environmental taxes.........................           7
53              Foundation and similar excise taxes.........          41
54              Pension excise taxes........................         258
55              Excise tax on real estate investment trusts 
                    and regulated investment companies......         492
56              Public charity excise taxes.................         498
141             Temporary excise tax regulations under the 
                    Employee Retirement Income Security Act 
                    of 1974.................................         538
143             Temporary excise tax regulations under the 
                    Tax Reform Act of 1969..................         538
145             Temporary excise tax regulations under the 
                    Highway Revenue Act of 1982 (Pub. L. 97-
                    424)....................................         540
148             Certain excise tax matters under the Excise 
                    Tax Technical Changes Act of 1958.......         550
151-155

[Reserved]

156             Excise tax on greenmail.....................         552
157             Excise tax on structured settlement 
                    factoring transactions..................         558
158-169

[Reserved]

                         SUBCHAPTER E [RESERVED]
170-299

[Reserved]


Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

  Additional supplementary publications are issued covering Alcohol, 
Tobacco and Firearms Regulations, and Regulations Under Tax Conventions.

[[Page 5]]



           SUBCHAPTER D_MISCELLANEOUS EXCISE TAXES (CONTINUED)


PART 50_REGULATIONS RELATING TO THE TAX IMPOSED WITH RESPECT TO CERTAIN HYDRAULIC MINING--Table of Contents



Sec.
50.1 Introduction.
50.2 Scope of regulations.
50.3 General definitions and use of terms.
50.4 Rates of tax.
50.5 Liability for the tax.
50.6 Ascertainment of quantity mined.
50.7 Returns.
50.8 Due date and place for filing returns and paying tax.

    Authority: Sec. 23, 27, Stat. 510, as amended; 33 U.S.C. 683.

    Source: T.D. 6419, 24 FR 8546, Oct. 22, 1959, unless otherwise 
noted.



Sec. 50.1  Introduction.

    The Act entitled ``An Act to create the California Debris Commission 
and regulate hydraulic mining in the State of California'', approved 
March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48 Stat. 1118; 
52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687, provides in part as 
follows:

    That a commission is hereby created, to be known as the California 
Debris Commission, consisting of three members. * * *
    Sec. 3. That the jurisdiction of said commission, insofar as the 
same affects mining carried on by the hydraulic process, shall extend to 
all such mining in the territory drained by the Sacramento and San 
Joaquin river systems in the State of California. * * *
    Sec. 8. That for the purposes of this act ``hydraulic mining'' and 
``mining by the hydraulic process,'' are hereby declared to have the 
meaning and application given to said terms in said State.
    Sec. 9. That the individual proprietor or proprietors, or in the 
case of a corporation its manager or agent appointed for that purpose, 
owning mining ground in the territory in the State of California 
mentioned in section three hereof, which it is desired to work by the 
hydraulic process, must file with said commission a verified petition, 
setting forth such facts as will comply with law and the rules 
prescribed by said commission.

                                * * * * *

    Sec. 13. That in case a majority of the members of said Commission, 
within thirty days after the time so fixed, concur in the decision in 
favor of the petitioner or petitioners, the said Commission shall 
thereupon make an order directing the methods and specifying in detail 
the manner in which operations shall proceed in such mine or mines; * * 
*
    Sec. 23. Upon the construction by the said commission of dams or 
other works for the detention of debris from hydraulic mines and the 
issuing of the order provided for by this Act to any individual, 
company, or corporation to work any mine or mines by hydraulic process, 
the individual, company, or corporation operating thereunder working any 
mine or mines by hydraulic process, the debris from which flows into or 
is in whole or in part restrained by such dams or other works erected by 
said commission, shall pay for each cubic yard mined from the natural 
bank a tax equal to the total capital cost of the dam, reservoir, and 
rights of way divided by the total capacity of the reservoir for the 
restraint of debris, as determined in each case by the California Debris 
Commission, which tax shall be paid annually on a date fixed by said 
commission and in accordance with regulations to be adopted by the 
Secretary of the Treasury, and the Treasurer of the United States is 
hereby authorized to receive the same. * * * The Secretary of the Army 
is authorized to enter into contracts to supply storage for water and 
use of outlet facilities from debris storage reservoirs, for domestic 
and irrigation purposes and power development upon such conditions of 
delivery, use, and payment as he may approve: Provided, That the moneys 
received from such contracts shall be deposited to the credit of the 
reservoir project from which the water is supplied, and the total 
capital cost of said reservoir, which is to be repaid by tax on mining 
operations as herein provided, shall be reduced in the amount so 
received.



Sec. 50.2  Scope of regulations.

    (a) In general. The regulations in this part relate to the tax 
imposed with respect to hydraulic mining, the debris from which flows 
into or is in whole or in part restrained by dams or other works erected 
for the detention of debris by the California Debris Commission in the 
area drained by the Sacramento and San Joaquin river systems in the 
State of California. The regulations have application to taxable years 
beginning after August 31, 1959.

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For definition of the term taxable year, see Sec. 50.3(g).
    (b) Extent to which the regulations in this part supersede prior 
regulations. The regulations in this part, with respect to the subject 
matter within the scope thereof, supersede Treasury Decision 4952 (26 
CFR (1939) part 317).



Sec. 50.3  General definitions and use of terms.

    As used in the regulations in this part:
    (a) The term Act means ``An Act to create the California Debris 
Commission and regulate hydraulic mining in the State of California'' 
approved March 1, 1893, as amended, 27 Stat. 507; 34 Stat. 1001; 48 
Stat. 1118; 52 Stat. 1040; 61 Stat. 501; 33 U.S.C. 661-687.
    (b) The term person means an individual, a trust, estate, 
partnership, company, or corporation.
    (c) The term Secretary means the Secretary of the Treasury.
    (d) The term Commissioner means the Commissioner of Internal 
Revenue.
    (e) The term district director means the district director of 
internal revenue.
    (f) The terms hydraulic mining and mining by the hydraulic process 
shall have the meaning and application given said terms in the State of 
California.
    (g) The term taxable year means the twelve-month period ending on 
August 31 of each year for which the tax imposed by the Act is payable.



Sec. 50.4  Rates of tax.

    (a) Determination of rate. Under the Act the California Debris 
Commission will determine and prescribe with respect to each debris dam 
or other works the rate of tax payable in the area served by the 
particular debris dam or works. The Secretary of the Army will notify 
the Secretary of the Treasury of the rate of tax fixed with respect to 
each debris dam or works as such rate becomes known.
    (b) Measure of tax. The tax is payable annually on the basis of the 
number of cubic yards mined from the natural bank by the hydraulic 
process during the taxable year.



Sec. 50.5  Liability for the tax.

    Liability for tax attaches to any person engaged at any time during 
the taxable year in hydraulic mining in the area identified in paragraph 
(a) of Sec. 50.2, if the debris from such mining operations is in whole 
or in part restrained by any of the debris dams or works constructed by 
the California Debris Commission.



Sec. 50.6  Ascertainment of quantity mined.

    Each person engaged in hydraulic mining operations within the scope 
of the tax shall make or cause to be made appropriate surveys of the 
premises on which such hydraulic mining operations are conducted for the 
purpose of determining the cubic yardage mined from the natural bank. 
Such surveys shall be made at the beginning and end of hydraulic mining 
operations in each taxable year by a licensed engineer or other 
qualified agency having prior approval of the California Debris 
Commission, and shall conform to requirements prescribed by the 
California Debris Commission.



Sec. 50.7  Returns.

    (a) Form of return. Every person liable for tax for any taxable year 
shall prepare for such year a return on Form 1 (California Debris) in 
accordance with the instructions thereon and in accordance with the 
regulations in this part.
    (b) Content of return. The return shall show:
    (1) The identity of the particular dam or other works restraining 
debris from the mine;
    (2) The name and location of the mine;
    (3) The name and address of the person to whom the California Debris 
Commission has issued a license to operate the mine;
    (4) The number and date of the license;
    (5) The name and address of the owner of the mine;
    (6) The dates on which hydraulic mining operations began and ended 
during the taxable year for which the return is made;
    (7) The number of cubic yards mined by the hydraulic process at the 
mine during the taxable year;

[[Page 7]]

    (8) The rate of tax per cubic yard determined by the California 
Debris Commission applicable to the particular mine; and
    (9) The amount of tax due and payable (cubic yards mined multiplied 
by the rate of tax per cubic yard).
    (c) Supporting statement. With each return there must be submitted a 
supporting statement of the person who made the surveys at the mine for 
the mining season covered by the return (see Sec. 50.6), stating that 
such surveys were made in accordance with requirements prescribed by the 
California Debris Commission.
    (d) Verification of return and supporting statement. The return and 
the supporting statement shall be verified by written declarations that 
they are made under the penalties of perjury.



Sec. 50.8  Due date and place for filing returns and paying tax.

    The return for a taxable year shall be filed with, and the tax shall 
be paid to, the district director at San Francisco, California, on or 
before September 30 of the calendar year in which the taxable year ends. 
The tax is due and payable on such date without assessment by, or notice 
from, the district director.



PART 52_ENVIRONMENTAL TAXES--Table of Contents



Sec.
52.0-1 Introduction.
52.4681-1 Taxes imposed with respect to ozone-depleting chemicals.
52.4682-1 Ozone-depleting chemicals.
52.4682-2 Qualifying sales.
52.4682-3 Imported taxable products.
52.4682-4 Floor stocks tax.
52.4682-5 Exports.

    Authority: 26 U.S.C. 7805.
    Section 52.4682-3 also issued under 26 U.S.C. 4682(c)(2);
    Section 52.4682-5 also issued under 26 U.S.C. 4662(e)(4).



Sec. 52.0-1  Introduction.

    The regulations in this part 52 are designated ``Environmental Tax 
Regulations.'' The regulations relate to the environmental taxes imposed 
by chapter 38 of the Internal Revenue Code. See part 40 of this chapter 
for regulations relating to returns, payments, and deposits of taxes 
imposed by chapter 38.

[T.D. 8442, 57 FR 48186, Oct. 22, 1992]



Sec. 52.4681-1  Taxes imposed with respect to ozone-depleting chemicals.

    (a) Taxes imposed. Sections 4681 and 4682 impose the following taxes 
with respect to ozone-depleting chemicals (ODCs):
    (1) Tax on ODCs. Section 4681(a)(1) imposes a tax on ODCs that are 
sold or used by the manufacturer or importer thereof. Except as 
otherwise provided in Sec. 52.4682-1 (relating to the tax on ODCs), the 
amount of the tax is equal to the product of--
    (i) The weight (in pounds) of the ODC;
    (ii) The base tax amount (determined under section 4681(b)(1) (B) or 
(C)) for the calendar year in which the sale or use occurs; and
    (iii) The ozone-depletion factor (determined under section 4682(b)) 
for the ODC.
    (2) Tax on imported taxable products. Section 4681(a)(2) imposes a 
tax on imported taxable products that are sold or used by the importer 
thereof. Except as otherwise provided in Sec. 52.4682-3 (relating to 
the tax on imported taxable products), the tax is computed by reference 
to the weight of the ODCs used as materials in the manufacture of the 
product. The amount of tax is equal to the tax that would have been 
imposed on the ODCs under section 4681(a)(1) if the ODCs had been sold 
in the United States on the date of the sale or use of the imported 
product. The weight of such ODCs is determined under Sec. 52.4682-3.
    (3) Floor stocks tax--(i) Imposition of tax. Section 4682(h) imposes 
a floor stocks tax on ODCs that--
    (A) Are held by any person other than the manufacturer or importer 
of the ODC on a date specified in paragraph (a)(3)(ii) of this section; 
and
    (B) Are held on such date for sale or for use in further 
manufacture.
    (ii) Dates on which tax imposed. The floor stocks tax is imposed on 
January 1 of each calendar year after 1989.
    (iii) Amount of tax. Except as otherwise provided in Sec. 52.4682-4 
(relating to the floor stocks tax), the amount of the

[[Page 8]]

floor stocks tax is equal to the excess of--
    (A) The tax that would be imposed on the ODC under section 
4681(a)(1) if a sale or use of the ODC by its manufacturer or importer 
occurred on the date the floor stocks tax is imposed (the tentative tax 
amount), over
    (B) The sum of the taxes previously imposed (if any) on the ODC 
under sections 4681 and 4682.
    (b) Cross-references--(1) Tax on ODCs. Additional rules relating to 
the tax on ODCs are contained in Sec. Sec. 52.4682-1 and 52.4682-2.
    (2) Tax on imported taxable products. Additional rules relating to 
the tax on imported taxable products are contained in Sec. 52.4682-3.
    (3) Floor stocks tax. Additional rules relating to the floor stocks 
tax are contained in Sec. 52.4682-4.
    (4) Returns, payments, and deposits of tax. Rules requiring returns 
reporting the taxes imposed by sections 4681 and 4682 are contained in 
part 40 of this chapter. Part 40 of this chapter also provides rules 
relating to the use of Government depositaries and to the time for 
filing returns and making payments of tax.
    (c) Definitions of general application. The following definitions 
set forth the meaning of certain terms for purposes of the regulations 
under sections 4681 and 4682:
    (1) Ozone-depleting chemical. The term ``ozone-depleting chemical'' 
(ODC) means any chemical listed in section 4682(a)(2).
    (2) United States. The term ``United States'' has the meaning given 
such term by section 4612(a)(4). Under section 4612(a)(4)--
    (i) The term ``United States'' means the 50 States, the District of 
Columbia, the Commonwealth of Puerto Rico, any possession of the United 
States, the Commonwealth of the Northern Mariana Islands, and the Trust 
Territory of the Pacific Islands; and
    (ii) The term includes--
    (A) Submarine seabed and subsoil that would be treated as part of 
the United States (as defined in paragraph (c)(2)(i) of this section) 
under the principles of section 638 relating to continental shelf areas; 
and
    (B) Foreign trade zones of the United States.
    (3) Manufacture; manufacturer. The term ``manufacture'' when used 
with respect to any ODC or imported product includes its production, and 
the term ``manufacturer'' includes a producer.
    (4) Entry into United States for consumption, use, or warehousing--
(i) In general. Except as otherwise provided in this paragraph (c)(4), 
the term ``entered into the United States for consumption, use, or 
warehousing'' when used with respect to any goods means--
    (A) Brought into the customs territory of the United States (the 
customs territory) if applicable customs law requires that the goods be 
entered into the customs territory for consumption, use, or warehousing;
    (B) Admitted into a foreign trade zone for any purpose if like goods 
brought into the customs territory for such purpose would be entered 
into the customs territory for consumption, use, or warehousing; or
    (C) Imported into any other part of the United States (as defined in 
paragraph (c)(2) of this section) for any purpose if like goods brought 
into the customs territory for such purpose would be entered into the 
customs territory for consumption, use, or warehousing.
    (ii) Entry for transportation and exportation. Goods entered into 
the customs territory for transportation and exportation are not goods 
entered for consumption, use, or warehousing.
    (iii) Entries described in two or more provisions. In the case of 
any goods with respect to which entries are described in two or more 
provisions of paragraph (c)(4)(i) of this section, only the first such 
entry is taken into account. Thus, if the admission of goods into a 
foreign trade zone is an entry into the United States for consumption, 
use, or warehousing, the subsequent entry of such goods into the customs 
territory will not be treated as an entry into the United States for 
consumption, use, or warehousing.
    (iv) Certain imported products not entered for consumption, use, or 
warehousing. Imported products that are entered into the United States 
for consumption, use, or warehousing do

[[Page 9]]

not include any imported products that--
    (A) Are entered into the customs territory under Harmonized Tariff 
Schedule (HTS) heading 9801, 9802, 9803, or 9813;
    (B) Would, if entered into the customs territory, be entered under 
any such heading; or
    (C) Are brought into the United States by an individual if the 
product is brought in for use by the individual and is not expected to 
be used in a trade or business other than a trade or business of 
performing services as an employee.
    (5) Importer. The term ``importer'' means the person that first 
sells or uses goods after their entry into the United States for 
consumption, use, or warehousing (within the meaning of paragraph (c)(4) 
of this section).
    (6) Sale. The term ``sale'' means the transfer of title or of 
substantial incidents of ownership (whether or not delivery to, or 
payment by, the buyer has been made) for consideration which may include 
money, services, or property. The determination as to the time a sale 
occurs shall be made under applicable local law.
    (7) Use--(i) In general. Except as otherwise provided in regulations 
under sections 4681 and 4682, ODCs and imported taxable products are 
used when they are--
    (A) Used as a material in the manufacture of an article, whether by 
incorporation into such article, chemical transformation, release into 
the atmosphere, or otherwise; or
    (B) Put into service in a trade or business or for production of 
income.
    (ii) Loss, destruction, packaging, warehousing, and repair. The 
loss, destruction, packaging (including repackaging), warehousing, or 
repair of ODCs and imported taxable products is not a use of the ODC or 
product lost, destroyed, packaged, warehoused, or repaired.
    (iii) Cross-references to exceptions. For exceptions to the rule 
contained in paragraph (c)(7)(i) of this section, see--
    (A) Section 52.4682-1(b)(2)(iii) (relating to mixture elections), 
Sec. 52.4682-1(b)(2)(iv) (relating to mixtures for export), and Sec. 
52.4682-1(b)(2)(v) (relating to mixtures for use as a feedstock);
    (B) Section 52.4682-3(c)(2) (relating to the election to treat entry 
of an imported taxable product as use); and
    (C) Section 52.4682-3(c)(3) (relating to treating sale of an article 
incorporating an imported taxable product as the first sale or use of 
the product).
    (8) Pound. The term ``pound'' means a unit of weight that is equal 
to 16 avoirdupois ounces.
    (9) Post-1990 ODC; post-1989 ODC. The term ``post-1990 ODC'' means 
any ODC that is listed below Halon-2402 in the table contained in 
section 4682(a)(2). The term ``post-1989 ODC'' means any ODC other than 
a post-1990 ODC.
    (d) Effective date. Sections 52.4681-0, 52.4681-1, 52.4682-1, 
52.4682-2, 52.4682-3, and 52.4682-4 are effective as of January 1, 1990, 
and apply to--
    (1) Post-1989 ODCs that the manufacturer or importer thereof first 
sells or uses after December 31, 1989, and post-1990 ODCs that the 
manufacturer or importer thereof first sells or uses after December 31, 
1990;
    (2) Imported taxable products that the importer thereof first sells 
or uses after December 31, 1989 (but, in the case of products first sold 
or used before January 1, 1991, by taking into account only the post-
1989 ODCs used as materials in their manufacture); and
    (3) Post-1989 ODCs held for sale or for use in further manufacture 
by any person other than the manufacturer or importer thereof on January 
1, 1990, and post-1989 and post-1990 ODCs that are so held on January 1 
of each calendar year after 1990.

[T.D. 8370, 56 FR 56305, Nov. 4, 1991, as amended by T.D. 8442, 57 FR 
48186, Oct. 22, 1992; T.D. 8622, 60 FR 52849, Oct. 11, 1995]



Sec. 52.4682-1  Ozone-depleting chemicals.

    (a) Overview. This section provides rules relating to the tax 
imposed on ozone-depleting chemicals (ODCs) under section 4681, 
including rules for identifying taxable ODCs and determining when the 
tax is imposed, and rules prescribing special treatment for certain 
ODCs. See Sec. 52.4681-1(a)(1) and (c) for general rules and 
definitions relating to the tax on ODCs.
    (b) Taxable ODCs; taxable event--(1) Taxable ODCs--(i) In general. 
Except as provided in paragraphs (c) through (g) of this section, an ODC 
is taxable if--

[[Page 10]]

    (A) It is listed in section 4682(a)(2) on the date it is sold or 
used by its manufacturer or importer; and
    (B) It is manufactured in the United States or entered into the 
United States for consumption, use, or warehousing.
    (ii) Storage containers. An ODC described in paragraph (b)(1)(i) of 
this section is taxable without regard to the type or size of storage 
container in which the ODC is held.
    (iii) Example. The application of this paragraph (b)(1) may be 
illustrated by the following example:

    Example. A brings CFC-12, an ODC listed in section 4682(a)(2), into 
the customs territory and enters the CFC-12 for transportation and 
exportation. The ODC is not taxable because it is not entered for 
consumption, use, or warehousing. The ODC also would not be taxable if 
it were admitted to a foreign trade zone (rather than brought into the 
customs territory) for transportation and exportation.

    (2) Taxable event--(i) In general--(A) General rule. The tax on an 
ODC is imposed when the ODC is first sold or used (as defined in Sec. 
52.4681-1(c)(6) and (7)) by its manufacturer or importer.
    (B) Example. The application of this paragraph (b)(2)(i) may be 
illustrated by the following example:

    Example. A enters CFC-113, an ODC listed in section 4682(a)(2), into 
the United States for consumption, use, or warehousing. A warehouses the 
CFC-113 and then decides to ship the ODC to its factory outside the 
United States (as defined in Sec. 52.4681-1 (c)(2)). The CFC-113 is a 
taxable ODC because the requirements of paragraph (b)(1)(i) of this 
section have been met. However, tax is not imposed on the ODC because 
there is no taxable event. A did not sell the ODC and, under Sec. 
52.4681-1(c)(7), warehousing is not a use.

    (ii) Mixtures. Except as provided in paragraphs (b)(2)(iii), (iv), 
and (v) of this section, the creation of a mixture containing two or 
more ingredients is treated as a taxable use of the ODCs contained in 
the mixture. For this purpose, a mixture cannot be represented by a 
chemical formula, and an ODC is contained in a mixture only if the 
chemical identity of the ODC is not changed. Thus, except as provided in 
paragraphs (b)(2)(iii), (iv), and (v) of this section--
    (A) The tax on the post-1989 ODCs (as defined in Sec. 52.4681-
1(c)(9)) contained in mixtures created after December 31, 1989, or on 
the post-1990 ODCs (as defined in Sec. 52.4681-1(c)(9)) contained in 
mixtures created after December 31, 1990, is imposed when the mixture is 
created and not on any subsequent sale or use of the mixture; and
    (B) No tax is imposed under section 4681 on the post-1989 ODCs 
contained in mixtures created before January 1, 1990, or on the post-
1990 ODCs contained in mixtures created before January 1, 1991.
    (iii) Mixture elections--(A) Permitted elections. The only elections 
permitted under this paragraph (b)(2)(iii) are--
    (1) An election for the first calendar quarter beginning after 
December 31, 1989, and all subsequent periods (the 1990 election); and
    (2) An election for the first calendar quarter beginning after 
December 31, 1990, and all subsequent periods (the 1991 election).
    (B) In general. A manufacturer or importer may elect to treat the 
sale or use of mixtures containing ODCs as the first sale or use of the 
ODCs contained in the mixtures. If a 1990 election is made under this 
paragraph (b)(2)(iii), the tax on post-1989 ODCs contained in a mixture 
sold or used after December 31, 1989 (including any such mixture created 
before January 1, 1990) is imposed on the date of such sale or use. 
Similarly, if a 1991 election is made under this paragraph (b)(2)(iii), 
the tax on post-1990 ODCs contained in a mixture sold or used after 
December 31, 1990 (including any such mixture created before January 1, 
1991) is imposed on the date of such sale or use.
    (C) Applicability of elections. An election under this paragraph 
(b)(2)(iii) applies--
    (1) In the case of a 1990 election, to all post-1989 ODCs contained 
in mixtures sold or used by the manufacturer or importer after December 
31, 1989 (including any such mixture created before January 1, 1990); 
and
    (2) In the case of a 1991 election, to all post-1990 ODCs contained 
in mixtures sold or used by the manufacturer or importer after December 
31, 1990 (including any such mixture created before January 1, 1991).
    (D) Making the election; revocation. An election under this 
paragraph (b)(2)(iii)

[[Page 11]]

shall be made in accordance with the instructions for the return on 
which the manufacturer or importer reports liability for tax under 
section 4681. After October 9, 1990, the election may be revoked only 
with the consent of the Commissioner.
    (iv) Special rule for exports. The creation of a mixture for export 
is not a taxable use of the ODCs contained in the mixture. If a 
manufacturer or importer sells a mixture for export, Sec. 52.4682-5 
applies to the ODCs contained in the mixture. See Sec. 52.4682-5(e) for 
rules relating to liability of a purchaser for tax if the mixture is not 
exported.
    (v) Special rule for use as a feedstock. The creation of a mixture 
for use as a feedstock (within the meaning of paragraph (c) of this 
section) is not a taxable use of the ODCs contained in the mixture.
    (c) ODCs used as a feedstock--(1) Exemption from tax. No tax is 
imposed on an ODC if the manufacturer or importer of the ODC--
    (i) Uses the ODC as a feedstock in the manufacture of another 
chemical; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (c)(4) of this section) for use as a feedstock.
    (2) Excess payments--(i) In general. Under section 4682(d)(2)(B), a 
credit or refund is allowed to a person if--
    (A) The person uses an ODC as a feedstock; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 was not determined under section 4682(d)(2)(A).
    (ii) Procedural rules. See section 6402 and the regulations 
thereunder for rules relating to claiming a credit or refund of tax paid 
with respect to ODCs that are used as a feedstock. A credit against the 
income tax is not allowed for the amount determined under section 
4682(d)(2)(B).
    (3) Definition. An ODC is used as a feedstock only if the ODC is 
entirely consumed (except for trace amounts) in the manufacture of 
another chemical. Thus, the transformation of an ODC into one or more 
new compounds (such as the transformation of CFC-113 into 
chlorotrifluoroethylene (CTFE or 1113), of CFC-113 into CFC-115 and CFC-
116, or of carbon tetrachloride into hydrochloric acid during petroleum 
refining or incineration) is treated as use as a feedstock. On the other 
hand, the ODCs used in a mixture (including an azeotrope such as R-500 
or R-502) are not used as a feedstock.
    (4) Qualifying sale. A sale of ODCs for use as a feedstock is a 
qualifying sale if the requirements of Sec. 52.4682-2(b)(1) are 
satisfied with respect to such sale.
    (d) ODCs used in the manufacture of rigid foam insulation--(1) 
Phase-in of tax--(i) In general. The amount of tax imposed on an ODC is 
determined under section 4682(g) if the manufacturer or importer of the 
ODC--
    (A) Uses the ODC during 1990, 1991, 1992, or 1993 in the manufacture 
of rigid foam insulation; or
    (B) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (d)(5) of this section) during 1990, 1991, 1992, or 1993.
    (ii) Amount of tax. Under section 4682(g), ODCs described in 
paragraph (d)(1)(i) of this section are not taxed if sold or used during 
1990 and are taxed at a reduced rate if sold or used during 1991, 1992, 
or 1993.
    (2) Excess payments--(i) In general. Under section 4682(g)(3), a 
credit against income tax or a refund is allowed to a person if--
    (A) The person uses an ODC during 1990, 1991, 1992, or 1993 in the 
manufacture of rigid foam insulation; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 was not determined under section 4682(g).
    (ii) Procedural rules--(A) The amount determined under section 
4682(g)(3) shall be treated as a credit described in section 34(a) 
(relating to credits for gasoline and special fuels) unless a claim for 
refund has been filed.
    (B) See section 6402 and the regulations thereunder for rules 
relating to claiming a credit or refund of the tax paid with respect to 
ODCs that are used in the manufacture of rigid foam insulation.
    (3) Definition--(i) Rigid foam insulation. The term ``rigid foam 
insulation'' means any rigid foam that is designed for use as thermal 
insulation in buildings, equipment, appliances, tanks, railcars, trucks, 
or vessels, or on pipes, including any such rigid foam actually

[[Page 12]]

used for purposes other than insulation. Information such as test 
reports on R-values and advertising material reflecting R-value claims 
for a particular rigid foam may be used to show that such rigid foam is 
designed for use as thermal insulation.
    (ii) Rigid foam--(A) In general. The term ``rigid foam'' means any 
closed cell polymeric foam (whether or not rigid) in which 
chlorofluorocarbons are used to fill voids within the polymer.
    (B) Examples of rigid foam products. Rigid foam includes extruded 
polystyrene foam, polyisocyanurate foam, spray and pour-in-place 
polyurethane foam, polyethylene foam, phenolic foam, and any other 
product that the Commissioner identifies as rigid foam in a 
pronouncement of general applicability. The form of a product identified 
under this paragraph (d)(3)(ii)(B) does not affect its character as 
rigid foam. Thus, such products are rigid foam whether in the form of a 
board, sheet, backer rod, or wrapping, or in a form applied by spraying, 
pouring, or frothing.
    (4) Use in manufacture. An ODC is used in the manufacture of rigid 
foam insulation if it is incorporated into such product or is expended 
as a propellant or otherwise in the manufacture or application of such 
product.
    (5) Qualifying sale. A sale of an ODC for use in the manufacture of 
rigid foam insulation is a qualifying sale if the requirements of Sec. 
52.4682-2(b)(2) are satisfied with respect to such sale.
    (e) Halons; phase-in of tax. The amount of tax imposed on Halon-
1211, Halon-1301, or Halon-2402 (Halons) is determined under section 
4682(g) if the manufacturer or importer of Halons sells or uses Halons 
during 1990, 1991, 1992, or 1993. Under section 4682(g), Halons are not 
taxed if sold or used during 1990 and are taxed at a reduced rate if 
sold or used during 1991, 1992, or 1993.
    (f) Methyl chloroform; reduced rate of tax in 1993. The amount of 
tax imposed on methyl chloroform is determined under section 4682(g)(5) 
if the manufacturer or importer of the methyl chloroform sells or uses 
it during 1993.
    (g) ODCs used as medical sterilants--(1) Phase-in of tax. The amount 
of tax imposed on an ODC is determined under section 4682(g)(4) if the 
manufacturer or importer of the ODC--
    (i) Uses the ODC during 1993 as a medical sterilant; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (g)(4) of this section) during 1993.
    (2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a 
credit against income tax (without interest) or a refund of tax (without 
interest) is allowed to a person if--
    (A) The person uses an ODC during 1993 as a medical sterilant; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 exceeds the amount that would have been determined under 
section 4682(g)(4).
    (ii) Amount of credit or refund. The amount of credit or refund of 
tax is equal to the excess of--
    (A) The tax that was paid with respect to the ODCs under sections 
4681 and 4682; over
    (B) The tax that would have been imposed under section 4682(g)(4).
    (iii) Procedural rules. (A) The amount determined under section 
4682(g)(4)(B) and paragraph (g)(2)(ii) of this section is treated as a 
credit described in section 34(a) (relating to credits for gasoline and 
special fuels) unless a claim for refund has been filed.
    (B) See section 6402 and the regulations under that section for 
procedural rules relating to claiming a credit or refund of tax.
    (3) Definition of use as a medical sterilant. An ODC is used as a 
medical sterilant if it is used in the manufacture of sterilant gas.
    (4) Qualifying sale. A sale of an ODC for use as a medical sterilant 
is a qualifying sale if the requirements of Sec. 52.4682-2(b)(3) are 
satisfied with respect to the sale.
    (h) ODCs used as propellants in metered-dose inhalers--(1) Reduced 
rate of tax. The amount of tax imposed on an ODC is determined under 
section 4682(g)(4) if the manufacturer or importer of the ODC--
    (i) Uses the ODC after 1992 as a propellant in a metered-dose 
inhaler; or
    (ii) Sells the ODC in a qualifying sale (within the meaning of 
paragraph (h)(4) of this section) after 1992.

[[Page 13]]

    (2) Excess payments--(i) In general. Under section 4682(g)(4)(B), a 
credit against income tax (without interest) or a refund of tax (without 
interest) is allowed to a person if--
    (A) The person uses an ODC after 1992 as a propellant in a metered-
dose inhaler; and
    (B) The amount of any tax paid with respect to the ODC under section 
4681 or 4682 exceeds the amount that would have been determined under 
section 4682(g)(4).
    (ii) Amount of credit or refund. The amount of credit or refund of 
tax is equal to the excess of--
    (A) The tax that was paid with respect to the ODCs under sections 
4681 and 4682; over
    (B) The tax that would have been imposed under section 4682(g)(4).
    (iii) Procedural rules--(A) The amount determined under section 
4682(g)(4)(B) and paragraph (h)(2)(ii) of this section is treated as a 
credit described in section 34(a) (relating to credits for gasoline and 
special fuels) unless a claim for refund has been filed.
    (B) See section 6402 and the regulations under that section for 
procedural rules relating to claiming a credit or refund of tax.
    (3) Definition of metered-dose inhaler. A metered-dose inhaler is an 
aerosol device that delivers a precisely-measured dose of a therapeutic 
drug.
    (4) Qualifying sale. A sale of an ODC for use as a propellant for a 
metered-dose inhaler is a qualifying sale if the requirements of Sec. 
52.4682-2(b)(4) are satisfied with respect to the sale.
    (i) [Reserved]
    (j) Exports; cross-reference. For the treatment of exports of ODCs, 
see Sec. 52.4682-5.
    (k) Recycling. [Reserved]

[T.D. 8370, 56 FR 56307, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52849, Oct. 11, 1995]



Sec. 52.4682-2  Qualifying sales.

    (a) In general--(1) Special rules applicable to certain sales. 
Special rules apply to sales of ODCs in the following cases:
    (i) Under section 4682(d)(2), Sec. 52.4682-1(c), and Sec. 52.4682-
4(b)(2)(v) (relating to ODCs used as a feedstock), ODCs sold in 
qualifying sales are not taxed.
    (ii) Under section 4682(g), Sec. 52.4682-1(d), and Sec. 52.4682-
4(d)(2) (relating to ODCs used in the manufacture of rigid foam 
insulation), ODCs sold in qualifying sales are not taxed in 1990 and are 
taxed at a reduced rate in 1991, 1992, and 1993.
    (iii) Under section 4682(g)(4) and Sec. 52.4682-1(g) (relating to 
ODCs used as medical sterilants), ODCs sold in qualifying sales are 
taxed at a reduced rate in 1993.
    (iv) Under section 4682(g)(4) and Sec. 52.4682-1(h) (relating to 
ODCs used as propellants in metered-dose inhalers), ODCs sold in 
qualifying sales are taxed at a reduced rate in years after 1992.
    (2) Qualifying sales. A sale of ODCs is not a qualifying sale unless 
the requirements of this section are satisfied. Although registration 
with the Internal Revenue Service is not required to establish that a 
sale of ODCs is a qualifying sale, the certificates required by this 
section shall be made available for inspection by internal revenue 
agents and officers.
    (b) Requirements for qualification--(1) Use as a feedstock. A sale 
of ODCs is a qualifying sale for purposes of Sec. Sec. 52.4682-1(c) and 
52.4682-4(b)(2)(v) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(2) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (2) Use in the manufacture of rigid foam insulation. A sale of ODCs 
is a qualifying sale for purposes of Sec. Sec. 52.4682-1(d) and 
52.4682-4(d)(2) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(3) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (3) Use as medical sterilants. A sale of ODCs is a qualifying sale 
for purposes of Sec. 52.4682-1(g) if the manufacturer or importer of 
the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(4) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.

[[Page 14]]

    (4) Use as propellants in metered-dose inhalers. A sale of ODCs is a 
qualifying sale for purposes of Sec. Sec. 52.4682-1(h) and 52.4682-
4(b)(2)(vii) if the manufacturer or importer of the ODCs--
    (i) Obtains a certificate in substantially the form set forth in 
paragraph (d)(5) of this section from the purchaser of the ODCs; and
    (ii) Relies on the certificate in good faith.
    (c) Good faith reliance--(1) In general. The requirements of 
paragraph (b) of this section are not satisfied with respect to a sale 
of ODCs and the sale is not a qualifying sale if at the time of the 
sale--
    (i) The manufacturer or importer has reason to believe that the 
purchaser will use the ODCs other than for the purpose set forth in the 
certificate; or
    (ii) The Internal Revenue Service has notified the manufacturer or 
importer that the purchaser's right to provide a certificate has been 
withdrawn.
    (2) Withdrawal of right to provide a certificate. The Internal 
Revenue Service may withdraw the right of a purchaser to provide a 
certificate to its supplier if such purchaser uses the ODCs to which its 
certificate applies other than for the purpose set forth in such 
certificate, or otherwise fails to comply with the terms of the 
certificate. The Internal Revenue Service may notify the supplier to 
whom the purchaser provided the certificate that the purchaser's right 
to provide a certificate has been withdrawn.
    (d) Certificate--(1) In general--(i) Rules relating to all 
certificates. This paragraph (d) sets forth certificates that satisfy 
the requirements of paragraphs (b)(1) through (4) of this section. The 
certificate shall consist of a statement executed and signed under 
penalties of perjury by a person with authority to bind the purchaser. A 
certificate provided under paragraph (d)(2) or (5) of this section may 
apply to a single purchase or to multiple purchases and need not specify 
an expiration date. A certificate provided under paragraph (d)(3) or (4) 
of this section may apply to a single purchase or multiple purchases, 
and will expire as of December 31, 1993, unless an earlier expiration 
date is specified in the certificate. A new certificate must be given to 
the supplier if any information on the current certificate changes. The 
certificate may be included as part of any business records normally 
used to document a sale.
    (ii) Special rule relating to certificates executed before January 
1, 1992. Certificates provided under this paragraph (d)(2) and executed 
before January 1, 1992, satisfy the requirements of paragraph (b) of 
this section if they are in substantially the same form as certificates 
set forth in Sec. 52.4682-2T.
    (2) Certificate relating to ODCs used as a feedstock--(i) ODCs that 
will be resold for use by the second purchaser as a feedstock. If the 
purchaser will resell the ODCs to a second purchaser for use by such 
second purchaser as a feedstock, the certificate provided by the 
purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Resold for Use by the 
                     Second Purchaser as a Feedstock

(To support tax-free sales under section 4682(d)(2) of the Internal 
Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as a feedstock (as defined in Sec. 52.4682-1(c)(3) of the 
Environmental Tax Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):

[[Page 15]]

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting 
chemicals covered by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________

________________________________________________________________________

Taxpayer Identifying Number

    (ii) ODCs that will be used by the purchaser as a feedstock. If the 
purchaser will use the ODCs as a feedstock, the certificate provided by 
the purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser 
                             as a Feedstock

(To support tax-free sales under section 4682(d)(2) of the Internal 
Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from
________________________________________________________________________
(name and address of seller)

will be used by Purchaser as a feedstock (as defined in Sec. 52.4682-
1(c)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                                                        Kilograms to be
             Product                   Percentage         transformed
------------------------------------------------------------------------
CFC-11...........................
CFC-12...........................
CFC-113..........................
CFC-114..........................
CFC-115..........................
Carbon tetrachloride.............
Methyl chloroform................
Other (specify)..................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):
------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 
4682(d)(2)(B) of the Internal Revenue Code for any ozone-depleting 
chemicals covered by this certificate.
    Purchaser understands that any use of the ozone-depleting chemicals 
to which this certificate applies other than as a feedstock may result 
in the withdrawal by the Internal

[[Page 16]]

Revenue Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as a feedstock of the ozone-depleting chemicals to which this 
certificate applies and will make such records available for inspection 
by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (3) Certificate relating to ODCs used in the manufacture of rigid 
foam insulation--(i) ODCs that will be resold to a second purchaser for 
use by the second purchaser in the manufacture of rigid foam insulation. 
If the purchaser will resell the ODCs to a second purchaser for use by 
such second purchaser in the manufacture of rigid foam insulation, the 
certificate provided by the purchaser must be in substantially the 
following form:

Certificate of Purchaser of Chemicals That Will Be Resold for Use by the 
      Second Purchaser in the Manufacture of Rigid Foam Insulation

(To support tax-free or tax-reduced sales under section 4682(g) of the 
Internal Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)

    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use in the manufacture of rigid foam insulation (as defined in Sec. 
52.4682-1(d)(3) and (4) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

 ------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(3) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-

[[Page 17]]

depleting chemicals to which this certificate applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing

________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (ii) ODCs that will be used by the purchaser in the manufacture of 
rigid foam insulation. If the purchaser will use the ODCs in the 
manufacture of rigid foam insulation, the certificate provided by the 
purchaser must be in substantially the following form:

Certificate of Purchaser of Chemicals That Will Be Used by the Purchaser 
               in the Manufacture of Rigid Foam Insulation

(To support tax-free or tax-reduced sales under section 4682(g) of the 
Internal Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
(not after 12/31/93)

    The undersigned purchaser (``Purchaser'') hereby certifies the 
following under penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased from

________________________________________________________________________
(name and address of seller)

will be used by Purchaser in the manufacture of rigid foam insulation 
(as defined in Sec. 52.4682-1(d) (3) and (4) of the Environmental Tax 
Regulations).

------------------------------------------------------------------------
                  Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................
CFC-12.....................................
CFC-113....................................
CFC-114....................................
CFC-115....................................
Carbon tetrachloride.......................
Methyl chloroform..........................
Other (specify)............................
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following Purchaser account 
number(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ All shipments to Purchaser under the following purchase order(s):

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

------ One or more shipments to Purchaser identified as follows:

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(3) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than in the 
manufacture of rigid foam insulation may result in the withdrawal by the 
Internal Revenue Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use in the manufacture of rigid foam insulation of the ozone-depleting 
chemicals to which this certificate applies and will make such records 
available for inspection by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Signature

________________________________________________________________________
Printed or typed name of person signing

________________________________________________________________________
Title of person signing
________________________________________________________________________
Name of Purchaser

________________________________________________________________________
Address

________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number

    (4) Certificate relating to ODCs used as medical sterilants--(i) 
ODCs that will be

[[Page 18]]

resold for use by the second purchaser as medical sterilants. If the 
purchaser will resell the ODCs to a second purchaser for use by such 
second purchaser as medical sterilants, the certificate provided by the 
purchaser must be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE 
                 SECOND PURCHASER AS MEDICAL STERILANTS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not after 12/31/93)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:

________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as medical sterilants (as defined in Sec. 52.4682-1(g)(3) of the 
Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-12.....................................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (ii) ODCs that will be used by the purchaser as medical sterilants. 
If the purchaser will use the ODCs as medical sterilants, the 
certificate provided by the purchaser must be in substantially the 
following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER 
                          AS MEDICAL STERILANTS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not after 12/31/93)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)


[[Page 19]]


will be used by Purchaser as medical sterilants (as defined in Sec. 
52.4682-1(g)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-12.....................................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as 
medical sterilants may result in the withdrawal by the Internal Revenue 
Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as medical sterilants of the ozone-depleting chemicals to which this 
certificate applies and will make such records available for inspection 
by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (5) Certificate relating to ODCs used as propellants in metered-dose 
inhalers--(i) ODCs that will be resold for use by the second purchaser 
as propellants in metered-dose inhalers. If the purchaser will resell 
the ODCs to a second purchaser for use by such second purchaser as 
propellants in metered-dose inhalers, the certificate provided by the 
purchaser must be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE RESOLD FOR USE BY THE 
        SECOND PURCHASER AS PROPELLANTS IN METERED-DOSE INHALERS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are purchasing the ozone-depleting chemicals for 
use as propellants in metered-dose inhalers (as defined in Sec. 
52.4682-1(h)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................     --------
CFC-12.....................................................     --------
CFC-114....................................................     --------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser 
          account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase 
          order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________

[[Page 20]]

________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than for the 
purpose set forth in this certificate may result in the withdrawal by 
the Internal Revenue Service of Purchaser's right to provide a 
certificate.
    Purchaser will retain the business records needed to document the 
sales covered by this certificate and will make such records available 
for inspection by Government officers. Purchaser also will retain and 
make available for inspection by Government officers the certificates of 
its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn. In addition, the 
Internal Revenue Service has not notified Purchaser that the right to 
provide a certificate has been withdrawn from any Second Purchaser who 
will purchase ozone-depleting chemicals to which this certificate 
applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (ii) ODCs that will be used by the purchaser as propellants in 
metered-dose inhalers. If the purchaser will use the ODCs as propellants 
in metered-dose inhalers, the certificate provided by the purchaser must 
be in substantially the following form:

CERTIFICATE OF PURCHASER OF CHEMICALS THAT WILL BE USED BY THE PURCHASER 
                 AS PROPELLANTS IN METERED-DOSE INHALERS

 (To support tax-reduced sales under section 4682(g)(4) of the Internal 
                             Revenue Code.)

Date____________________________________________________________________
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)

will be used by Purchaser as propellants in metered-dose inhalers (as 
defined in Sec. 52.4682-1(h)(3) of the Environmental Tax Regulations).

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................     --------
CFC-12.....................................................     --------
CFC-114....................................................     --------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

-------- All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following Purchaser 
          account number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- All shipments to Purchaser under the following purchase 
          order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
-------- One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser will not claim a credit or refund under section 4682(g)(4) 
of the Internal Revenue Code for any ozone-depleting chemicals covered 
by this certificate.
    Purchaser understands that any use by Purchaser of the ozone-
depleting chemicals to which this certificate applies other than as 
propellants in metered-dose inhalers may result in the withdrawal by the 
Internal Revenue Service of Purchaser's right to provide a certificate.
    Purchaser will retain the business records needed to document the 
use as propellants in metered-dose inhalers of the ozone-depleting 
chemicals to which this certificate applies and will make such records 
available for inspection by Government officers.
    Purchaser has not been notified by the Internal Revenue Service that 
its right to provide a certificate has been withdrawn.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment,

[[Page 21]]

or both, together with the costs of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

[T.D. 8370, 56 FR 56308, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52850, Oct. 11, 1995]



Sec. 52.4682-3  Imported taxable products.

    (a) Overview; references to Tables; special rule for 1990--(1) 
Overview. This section provides rules relating to the tax imposed on 
imported taxable products under section 4681, including rules for 
identifying imported taxable products, determining the weight of the 
ozone-depleting chemicals (ODCs) used as materials in the manufacture of 
such products, and computing the amount of tax on such products. See 
Sec. 52.4681-1(a)(2) and (c) for general rules and definitions relating 
to the tax on imported taxable products.
    (2) References to Tables. When used in this section--
    (i) The term Imported Products Table (Table) refers to the Table set 
forth in paragraph (f)(6) of this section; and
    (ii) The term current Imported Products Table (current Table) used 
with respect to a product refers to the Table in effect on the date such 
product is first sold or used by the importer thereof.
    (3) Special rule for 1990. In the case of products first sold or 
used before January 1, 1991, post-1990 ODCs (as defined in Sec. 
52.4681-1(c)(9)) shall not be taken into account in applying the rules 
of this section.
    (b) Imported taxable products--(1) In general--(i) Rule. Except as 
provided in paragraph (b)(2) of this section, the term ``imported 
taxable product'' means any product that--
    (A) Is entered into the United States for consumption, use, or 
warehousing; and
    (B) Is listed in the current Table.
    (ii) Example. The application of this paragraph (b)(1) may be 
illustrated by the following example:

    Example. A brings a light truck with a Harmonized Tariff Schedule 
classification of 8704 into the customs territory and enters the truck 
for transportation and exportation. Although the truck is listed in the 
current Table, it is not an imported taxable product because it is not 
entered for consumption, use, or warehousing. The truck also would not 
be an imported taxable product if it were admitted to a foreign trade 
zone (rather than brought into the customs territory) for transportation 
and exportation.

    (2) Exceptions--(i) In general. A product is not treated as an 
imported taxable product if--
    (A) The product is listed in Part I of the current Table and the 
adjusted tax with respect to the product is de minimis (within the 
meaning of paragraph (b)(2)(ii) of this section); or
    (B) The product is listed in Part II of the current Table, the 
adjusted tax with respect to the product is de minimis (within the 
meaning of paragraph (b)(2)(ii) of this section), and the ODCs (other 
than methyl chloroform) used as materials in the manufacture of the 
product were not used for purposes of refrigeration or air conditioning, 
creating an aerosol or foam, or manufacturing electronic components.
    (ii) De minimis adjusted tax. The adjusted tax with respect to a 
product is de minimis if such tax is less than one/tenth of one percent 
of the importer's cost of acquiring such product. The term adjusted tax 
means the tax that would be imposed under section 468l on the ODCs used 
as materials in the manufacture of such product if such ODCs were sold 
in the United States and the base tax amount were $1.00.
    (c) Taxable event--(1) In general. Except as otherwise provided in 
paragraphs (c) (2) and (3) of this section, the tax on an imported 
taxable product is imposed when the product is first sold or used (as 
defined in Sec. 52.4681-1(c) (6) and (7)) by its importer. Thus, for 
example, imported taxable products that are warehoused or repackaged 
after entry and then exported without being sold or used in the United 
States are not subject to tax.
    (2) Election to treat importation as use--(i) In general. An 
importer may elect to treat the entry of products

[[Page 22]]

into the United States as the use of such products. In the case of 
imported taxable products to which an election under this paragraph 
(c)(2) applies--
    (A) Tax is imposed on the products on the date of entry (as 
determined under paragraph (c)(2)(ii) of this section) if the products 
are entered into the United States after the election becomes effective;
    (B) Tax is imposed on the products on the date the election becomes 
effective if the products were entered into the United States after 
December 3l, 1989, and before the election becomes effective; and
    (C) No tax is imposed if the products were entered into the United 
States before January 1, 1990.
    (ii) Date of entry. The date of entry is determined by reference to 
customs law. If the actual date is unknown, the importer may use any 
reasonable and consistent method to determine the date of entry, 
provided that such date is within 10 business days of arrival of 
products in the United States.
    (iii) Applicability of election. An election under this paragraph 
(c)(2) applies to all imported taxable products that are owned (and have 
not been used) by the importer at the time the election becomes 
effective and all imported taxable products that are entered into the 
United States by the importer after the election becomes effective. An 
election under this paragraph (c)(2) becomes effective at the beginning 
of the first calendar quarter to which the election applies. After 
October 9, 1990, the election may be revoked only with the consent of 
the Commissioner.
    (iv) Making the election. An election under this paragraph (c)(2) 
shall be made in accordance with the instructions for the return on 
which the importer is required to report liability for tax under section 
4681.
    (3) Treating the sale of an article incorporating an imported 
taxable product as the first sale or use of such product--(i) In 
general. In the case of articles to be sold, an importer may treat the 
sale of an article manufactured or assembled in the United States as the 
first sale or use of an imported taxable product incorporated in such 
article, but only if the importer--
    (A) Has consistently treated the sale of similar articles as the 
first sale or use of similar imported taxable products; and
    (B) Has not made an election under paragraph (c)(2) of this section.
    (ii) Similar articles and imported taxable products. An importer may 
establish any reasonable criteria for determining whether articles or 
imported taxable products are similar for purposes of this paragraph 
(c)(3).
    (iii) Establishment of consistent treatment. An importer has 
consistently treated the sale of similar articles as the first sale or 
use of similar imported taxable products only if such treatment is 
reflected in the computation of tax on the importer's returns for all 
prior calendar quarters in which such treatment would affect tax 
liability.
    (iv) Example. The application of this paragraph (c)(3) may be 
illustrated by the following example:

    Example. (a) An importer of printed circuits and other electronic 
components uses those products in assembling television receivers in the 
United States and also uses the printed circuits in assembling VCRs in 
the United States. Under the importer's criteria for determining 
similarity, printed circuits are similar to other printed circuits, but 
not to the other electronic components. In addition, television 
receivers are similar to other television receivers, but not to VCRs. 
The importer has not made an election under paragraph (c)(2) of this 
section.
    (b) Under this paragraph (c)(3), the importer may treat the sale of 
the television receivers as the first sale or use of the imported 
printed circuits incorporated into the television receivers. In that 
case, the tax on the printed circuits would be imposed when the 
television receivers are sold rather than when the printed circuits are 
used in assembling the television receivers.
    (c) The importer may treat the sale of the television receivers as 
the first sale or use of the printed circuits incorporated into the 
television receivers even if the sale of the television receivers is not 
treated as the first sale or use of the other electronic components 
incorporated into the television receivers and even if the sale of VCRs 
is not treated as the first sale or use of the printed circuits 
incorporated into the VCRs. Under paragraph (c)(3)(i)(A) of this 
section, however, the importer must have consistently treated the sale 
of television receivers as the first sale or use of printed circuits 
incorporated into the receivers. Thus, in the case of television 
receivers that were assembled

[[Page 23]]

before January 1, 1990, and sold after December 31, 1989, the importer 
must have treated the sale of the television receivers as the first sale 
or use of the printed circuits incorporated into the television 
receivers when reporting tax under section 4681 with respect to such 
printed circuits.

    (d) ODCs used as materials in the manufacture of imported taxable 
products--(1) ODC weight. The tax imposed on an imported taxable product 
under section 4681 is computed by reference to the weight of the ODCs 
used as materials in the manufacture of the product (ODC weight). The 
ODC weight of a product includes the weight of ODCs used as materials in 
the manufacture of any components of the product.
    (2) ODCs used as materials in the manufacture of a product. Except 
as provided in paragraph (d)(3) of this section, an ODC is used as a 
material in the manufacture of a product if the ODC is--
    (i) Incorporated into the product;
    (ii) Released into the atmosphere in the process of manufacturing 
the product; or
    (iii) Otherwise used in the manufacture of the product (but only to 
the extent the cost of the ODC is properly allocable to the product).
    (3) Protective packaging. ODCs used in the manufacture of the 
protective material in which a product is packaged are not treated as 
ODCs used as materials in the manufacture of such product.
    (4) Examples. The provisions of this paragraph (d) may be 
illustrated by the following examples:

    Example 1. A, a manufacturer located outside the United States, uses 
ODCs as a solvent to clean the printed circuits it manufactures and as a 
coolant in the air-conditioning system of the factory in which the 
printed circuits are manufactured. The ODCs used as a solvent are 
released into the atmosphere, and, under paragraph (d)(2)(ii) of this 
section, are used as materials in the manufacture of the printed 
circuits. The ODCs used as a coolant in the air-conditioning system are 
also used in the manufacture of the printed circuits. Under paragraph 
(d)(2)(iii) of this section, these ODCs are used as materials in the 
manufacture of the printed circuits only to the extent the cost of the 
ODCs is properly allocable to the printed circuits.
    Example 2. B manufactures television receivers outside the United 
States and wraps them for shipping in a protective packing material 
manufactured with ODCs. Under paragraph (d)(3) of this section, the ODCs 
used in the manufacture of the protective packing material are not 
treated as ODCs used as a material in the manufacture of the television 
receivers.

    (e) Methods of determining ODC weight; computation of tax--(1) In 
general. This paragraph (e) sets forth the methods to be used for 
determining the ODC weight of an imported taxable product and a method 
to be used in computing the tax when the ODC weight cannot be 
determined. The amount of tax is computed separately for each imported 
taxable product and the method to be used in determining the ODC weight 
or otherwise computing the tax is separately determined for each such 
product. Thus, an importer may use one method in computing the tax on 
some imported taxable products and different methods in computing the 
tax on other products. For example, an importer of telephone sets may 
compute the tax using the exact method described in paragraph (e)(2) of 
this section for determining the ODC weight of telephone sets supplied 
by one manufacturer and using the Table method described in paragraph 
(e)(3) of this section for telephone sets supplied by other 
manufacturers that have not provided sufficient information to allow the 
importer to use the exact method.
    (2) Exact method. If the importer determines the weight of each ODC 
used as a material in the manufacture of an imported taxable product and 
supports that determination with sufficient and reliable information, 
the ODC weight of the product is the weight so determined. Under this 
method, the ODC weight of a mixture is equal to the weight of the ODCs 
contained in the mixture. Representations by the manufacturer of the 
product to the importer as to the weight of the ODCs used as materials 
in the manufacture of the product may be sufficient and reliable 
information for this purpose. Thus, a letter to the importer signed by 
the manufacturer may constitute sufficient and reliable information if 
the letter adequately identifies the product and states the weight of 
each ODC used as a material in the product's manufacture.

[[Page 24]]

    (3) Table method--(i) In general. If the ODC weight of an imported 
taxable product is not determined using the exact method described in 
paragraph (e)(2) of this section and the current Table specifies an ODC 
weight for the product, the ODC weight of the product is the Table ODC 
weight, regardless of what ODCs were used in the manufacture of the 
product. In computing the amount of tax, the Table ODC weight shall not 
be rounded.
    (ii) Special rules--(A) Articles assembled in the United States. An 
importer that assembles finished articles in the United States may 
compute the amount of tax imposed on the imported taxable products 
incorporated into the finished article by using the Table ODC weight 
specified for the article instead of the Table ODC weights specified for 
the components. In order to compute the tax under this special rule, the 
importer must determine the actual number of articles manufactured. For 
example, if an importer manufactures 100 camcorders using imported 
subassemblies, the importer may compute the amount of tax on the 
subassemblies by using the Table ODC weight specified for camcorders. 
Thus, the tax imposed on the subassemblies is equal to the tax that 
would be imposed on 100 camcorders.
    (B) Combination method. This paragraph (e)(3)(ii)(B) applies to an 
imported taxable product if the current Table specifies weights for two 
or more ODCs with respect to the product and the importer of the product 
can determine the weight of any such ODC (and of any ODC used as a 
substitute for such ODC) and can support such determination with 
sufficient and reliable information. In determining the ODC weight of 
any such product, the importer may replace the weight specified in the 
Table for such ODC with the weight (as determined by the importer) of 
such ODC and its substitutes. For example, if an importer has sufficient 
and reliable information to determine the amount of CFC-12 included in a 
product as a coolant (and to determine that no ODCs have been used as 
substitutes for CFC-12) but cannot determine the amount of CFC-113 used 
in manufacturing the product's electronic components, the importer may 
use the weight specified in the Table for CFC-113 and the actual weight 
determined by the importer for CFC-12 in determining the ODC weight of 
the product.
    (C) ODCs used in the manufacture of rigid foam insulation. In 
computing the tax using the method described in this paragraph (e)(3), 
any ODC for which the Table specifies a weight followed by an asterisk 
(*) shall be treated as an ODC used in the manufacture of rigid foam 
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)).
    (4) Value method--(i) General rule. If the importer cannot determine 
the ODC weight of an imported taxable product under the exact method 
described in paragraph (e)(2) of this section and the Table ODC weight 
of the product is not specified, the tax imposed on the product under 
section 4681 is one percent of the entry value of the product.
    (ii) Special rule for mixtures. If, in the case of an imported 
taxable product that is a mixture, the tax was determined under the 
method described in this paragraph (e)(4), the Commissioner may 
redetermine the tax based on the ODC weight of the mixture.
    (5) Adjustment for prior taxes--(i) In general. If any manufacture 
with respect to an imported taxable product occurred in the United 
States or the product incorporates a taxed component or a taxed chemical 
was used in its manufacture, the product's ODC weight (or value) 
attributable to manufacture within the United States or to taxed 
components or taxed chemicals shall be disregarded in computing the tax 
on such product using a method described in paragraph (e) (2), (3), or 
(4) of this section.
    (ii) Taxed component. The term ``taxed component'' means any 
component that previously was subject to tax as an imported taxable 
product or that would have been so taxed if section 4681 had been in 
effect for periods before January 1, 1990.
    (iii) Taxed chemical. The term ``taxed chemical'' means any ODC that 
previously was subject to tax.
    (6) Examples. The application of this paragraph (e) may be 
illustrated by the following examples:


[[Page 25]]


    Example 1. A is an importer (as defined in Sec. 52.4681-1(c)(5)) of 
VCRs. The HTS classification for the VCRs is 8528.10.40. VCRs classified 
under HTS heading 8528.10.40 are imported taxable products because they 
are listed in the Table (contained in paragraph (f)(6) of this section) 
by name and HTS heading (as described in paragraph (f)(3)(i) of this 
section). Each VCR is wrapped in protective packing material 
manufactured with ODCs. A imports and sells 100 VCRs during the first 
calendar quarter of 1991. A may determine the ODC weight for the VCRs by 
reference to the Table. The Table ODC weight specified for VCRs 
classified under HTS heading 8528.10.40 is 0.0586 pound of CFC-113. This 
weight does not take protective packaging into account. The amount of 
tax for the first quarter of 1991 is $6.42 (0.0586 (the ODC weight) x 
100 (the number of VCRs sold in the quarter) x $1.37 (the base tax 
amount for CFC-113 in 1991) x 0.8 (the ozone-depletion factor for CFC-
113)). If A uses the exact method (as described in paragraph (e)(2) of 
this section) to determine the ODC weight for the VCRs, A does not take 
into account the ODCs used in the manufacture of the protective 
packaging. (Imported protective packaging containing foams made with 
ODCs other than foams defined in Sec. 52.4682-1(d)(3) is subject to 
tax, however, if the packaging is sold as packaging or first used as 
packaging in the United States.)
    Example 2. The facts are the same as in Example 1, except that A's 
VCRs are manufactured using methyl chloroform as the solvent instead of 
CFC-113. If A does not use the exact method to determine the weight of 
the methyl chloroform used in the manufacture of the VCRs, A must, under 
paragraphs (e)(3)(i) and (e)(4)(i) of this section, determine the ODC 
weight by reference to the Table. If A uses the Table ODC weight, the 
computation of tax is the same as in Example 1, using the base tax 
amount and ozone-depletion factor for CFC-113. A does not substitute the 
base tax amount and ozone-depletion factor of methyl chloroform for 
those of CFC-113.
    Example 3. B imports and sells mixtures of ethylene oxide and CFC-
12. The mixture is 88 percent CFC-12 by weight. B also imports and sells 
R-502. The R-502 is 51 percent CFC-115 by weight. In the first calendar 
quarter of 1991 B sells 100 pounds of imported ethylene oxide/CFC-12 
mixture and 10,000 pounds of imported R-502. The ethylene/CFC-12 mixture 
and the R-502 are imported taxable products because they are listed in 
Part I of the Table (contained in paragraph (f)(6) of this section). 
Under the exact method described in paragraph (e)(2) of this section, B 
computes the tax based on 88 pounds of CFC-12, the amount of ODCs 
contained in the imported ethylene oxide mixture, and based on 5100 
pounds of CFC-115, the amount of ODCs in the imported R-502.

    (f) Imported Products Table--(1) In general. This paragraph (f) 
contains rules relating to the Imported Products Table (Table) and sets 
forth the Table. The Table lists all the products that are subject to 
the tax on imported taxable products and specifies the Table ODC weight 
of each product for which such a weight has been determined.
    (2) Applicability of Table--(i) In general. Except as provided in 
paragraph (f)(2)(ii) of this section, the Table contained in paragraph 
(f)(6) of this section is effective on January 1, 1990.
    (ii) Treatment of certain products--(A) Products included in a 
listing that is preceded by a double asterisk (**) in the Table shall 
not be treated as imported taxable products until October 1, 1990.
    (B) Products included in a listing that is preceded by a triple 
asterisk (***) in the Table shall not be treated as imported taxable 
products until January l, 1992.
    (3) Identification of products--(i) In general. Each listing in the 
Table identifies a product by name and includes only products that are 
described by that name. Most listings (other than listings for mixtures) 
identify a product by both name and HTS heading. In such cases, a 
product is included in that listing only if the product is described by 
that name and the rate of duty on the product is determined by reference 
to that HTS heading. However, the product is included in that listing 
even if it is manufactured with or contains a different ODC than the ODC 
specified in the Table.
    (ii) Electronic items not listed by specific name--(A) In general. 
Part II of the Table contains listings for electronic items that are not 
included within any other listing in the Table. An imported product is 
included in these listings only if such imported product--
    (1) Is an electronic component listed in chapters 84, 85, or 90 of 
the Harmonized Tariff Schedule; or
    (2) Contains components described in paragraph (f)(3)(ii)(A)(1) of 
this section and more than 15 percent of the cost of the imported 
product is attributable to such components.
    (B) Electronic component. For purposes of this paragraph (f)(3)(ii), 
an electronic component is a component

[[Page 26]]

whose operation involves the use of nonmechanical amplification or 
switching devices such as tubes, transistors, and integrated circuits. 
Such components do not include passive electrical devices such as 
resistors and capacitors.
    (C) Certain items not included. Items such as screws, nuts, bolts, 
plastic parts, and similar specially fabricated parts that may be used 
to construct an electronic item are not themselves included in the 
listing for electronic items not otherwise listed in the Table.
    (iii) Examples. The application of this paragraph (f)(3) may be 
illustrated by the following examples:

    Example 1. The Table lists ``electronic integrated circuits and 
microassemblies; HTS heading 8542.'' A bipolar transistor under HTS 
heading 8542.11.00.05 is included in this listing because a bipolar 
transistor is a type of electronic integrated circuit and HTS heading 
8542.11.00.05 is included within HTS heading 8542.
    Example 2. The Table lists ``radios; HTS heading 8527.19,'' ``radio 
combinations; HTS heading 8527.11'' and ``radio combinations; HTS 
heading 8527.31.'' A radio classified under HTS heading 8527.19 is not 
included within either listing for radio combinations. However, a radio 
classified under HTS heading 8527.19.00.20 is included within the 
listing for radios; HTS heading 8527.19. A radio combination classified 
under HTS heading 8527.11.20 is included within the listing for radio 
combinations; HTS heading 8527.11 but not the listing for radio 
combinations; HTS heading 8527.31. Any radio or radio combination not 
classified under the HTS heading for any other listing is included in 
the listing for electronic items not otherwise listed.

    (4) Rules for listing products. Products are listed in the Table in 
accordance with the following rules:
    (i) Listing in part I. A product is listed in part I of the Table if 
it is a mixture containing ODCs. In addition, a product other than a 
mixture containing ODCs will be listed in part I of a revised Table if 
the Commissioner has determined that--
    (A) The ODC weight of the product is not de minimis when the product 
is produced using the predominant method of manufacturing the product; 
and
    (B) None of the ODCs used as materials in the manufacture of the 
product under the predominant method are used for purposes of 
refrigeration or air conditioning, creating an aerosol or foam, or 
manufacturing electronic components.
    (ii) Listing in part II. A product is listed in part II of the Table 
if the Commissioner has determined that the ODCs used as materials in 
the manufacture of the product under the predominant method are used for 
purposes of refrigeration or air conditioning, creating an aerosol or 
foam, or manufacturing electronic components.
    (iii) Listing in part III. A product is listed in part III of the 
Table if the Commissioner has determined that the product is not an 
imported taxable product and the product would otherwise be included 
within a listing in part II of the Table. For example, floppy disk drive 
units are listed in part III because they are not imported taxable 
products and they would, but for their listing in part III, be included 
within the part II listing for electronic items not specifically 
identified.
    (5) Table ODC weight. The Table ODC weight of a product is the 
weight, determined by the Commissioner, of the ODCs that are used as 
materials in the manufacture of the product under the predominant method 
of manufacturing. The Table ODC weight is given in pounds per single 
unit of product unless otherwise specified.
    (6) Table. The Table is set forth below:

                                             Imported Products Table
----------------------------------------------------------------------------------------------------------------
                                                                    Harmonized
                                                                      tariff
                          Product name                               schedule           ODC         ODC weight
                                                                      heading
----------------------------------------------------------------------------------------------------------------
Part I--Products that are mixtures containing ODCs:
Mixtures containing ODCs, including but not limited to:
    --anti-static sprays........................................
    --automotive products such as ``carburetor cleaner,'' ``stop
     leak,'' and ``oil charge''.................................
    --cleaning solvents.........................................
    --contact cleaners..........................................
    --degreasers................................................

[[Page 27]]

 
    --dusting sprays............................................
    --electronic circuit board coolants.........................
    --electronic solvents.......................................
    --ethylene oxide/CFC-12.....................................
    --fire extinguisher preparations and charges................
    --flux removers for electronics.............................
    --insect and wasp sprays....................................
    --mixtures of ODCs..........................................
    --propellants...............................................
    --refrigerants..............................................  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                           Harmonized
                                             tariff
              Product name                  schedule                ODC                      ODC weight
                                             heading
----------------------------------------------------------------------------------------------------------------
Part II--Products in which ODCs are
 used for purposes of refrigeration or
 air conditioning, creating an aerosol
 or form or manufacturing electronic
 components:
    Rigid foam insulation defined in     ..............  .........................  ............................
     Sec.  52.4682-1(d)(3).
    Foams made with ODCs, other than     ..............  .........................  ............................
     foams defined in Sec.  52.4682-
     1(d)(3).
    Scrap flexible foams made with ODCs  ..............  .........................  ............................
    Medical products containing ODCs:
        Surgical staplers..............  ..............  .........................  ............................
        Cryogenic medical instruments..  ..............  .........................  ............................
        Drug delivery systems..........  ..............  .........................  ............................
        Inhalants......................  ..............  .........................  ............................
    Dehumidifiers, household...........   8415.82.00.50  CFC-12...................  0.344
    Chillers:..........................   8415.82.00.65  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1600.
        Charged with CFC-114...........  ..............  CFC-114..................  1250.
        Charged with R-500.............  ..............  CFC-12...................  1920.
    Refrigerator-freezers, household:
        Not  184 liters.....   8418.10.00.10  CFC-11...................  \1\1.08
                                                         CFC-12...................  0.13
         184 liters but not    8418.10.00.20  CFC-11...................  \1\1.32
          269 liters.                         CFC-12...................  0.26
         269 liters but not    8418.10.00.30  CFC-11...................  \1\1.54
          382 liters.                         CFC-12...................  0.35
         382 liters.........   8418.10.00.40  CFC-11...................  \1\1.87
                                                         CFC-12...................  0.35
    Refrigerators, household:
        Not  184 liters.....   8418.21.00.10  CFC-11...................  \1\1.08
                                                         CFC-12...................  0.13
         184 liters but not    8418.21.00.20  CFC-11...................  \1\1.32
          269 liters.                         CFC-12...................  0.26
         269 liters but not    8418.21.00.30  CFC-11...................  \1\1.54
          382 liters.                         CFC-12...................  0.35
         382 liters.........   8418.21.00.90  CFC-11...................  \1\1.87
                                                         CFC-12...................  0.35
    Freezers, household................         8418.30  CFC-11...................  \1\ 2.0
                                                         CFC-12...................  0.4
    Freezers, household................         8418.40  CFC-11...................  \1\2.0
                                                         CFC-12...................  0.4
    Refrigerating display counters not          8418.50  CFC-11...................  \1\ 50.0
      227 kg.                                 CFC-12...................  260.0
    Icemaking machines.................         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1.4
        Charged with R-502.............  ..............  CFC-115..................  3.39
    Drinking water coolers.............         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  0.21
        Charged with R-500.............  ..............  CFC-12...................  0.22
    Centrifugal chillers, hermetic.....         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  1600.
        Charged with CFC-114...........  ..............  CFC-114..................  1250.
        Charged with R-500.............  ..............  CFC-12...................  1920.
    Reciprocating chillers.............         8418.69  .........................  ............................
        Charged with CFC-12............  ..............  CFC-12...................  200.
    Mobile refrigeration systems.......         8418.99  .........................  ............................
        Containers.....................  ..............  CFC-12...................  15.

[[Page 28]]

 
        Trucks.........................  ..............  CFC-12...................  11.
        Trailers.......................  ..............  CFC-12...................  20.
    Refrigeration condensing units:
        not  746W...........   8418.99.00.05  CFC-12...................  0.3
         746W but not  2.2KW.
         2.2KW but not  7.5KW.
         7.5KW but not  22.3KW.
         22.3 KW............   8418.99.00.25  CFC-12...................  17.0
    Fire extinguishers, charged w/ODCs.            8424  .........................  ............................
    Electronic typewriters and word                8469  CFC-113..................  0.2049
     processors.
    Electronic calculators.............         8470.10  CFC-113..................  0.0035
    Electronic calculators w/printing           8470.21  CFC-113..................  0.0057
     device.
    Electronic calculators.............         8470.29  CFC-113..................  0.0035
    Account machines...................         8470.40  CFC-113..................  0.1913
    Cash registers.....................         8470.50  CFC-113..................  0.1913
    Digital automatic data processing           8471.20  CFC-113..................  0.3663
     machines w/cathode ray tube, not
     included in subheading
     8471.20.00.90.
    Laptops, notebooks, and pocket        8471.20.00.90  CFC-113..................  0.03567
     computers.
    Digital processing units w/entry
     value:
        Not  $100K..........         8471.91  CFC-113..................  0.4980
         $100K..............         8471.91  CFC-113..................  27.6667
    Combined input/output units                 8471.92  CFC-113..................  0.3600
     (terminals).
    Keyboards..........................         8471.92  CFC-113..................  0.0742
    Display units......................         8471.92  CFC-113..................  0.0386
    Printer units......................         8471.92  CFC-113..................  0.1558
    lnput or output units..............         8471.92  CFC-113..................  0.1370
    Hard magnetic disk drive units not
     included in subheading 8471.93.10
     for a disk of a diameter:
        Not  9 cm (3\1/2\            8471.93  CFC-113..................  0.2829
         inches).
         9 cm (3\1/2\                8471.93  CFC-113..................  1.1671
         inches) but not  21
         cm (8\1/4\ inches).
    Nonmagnetic storage units w/ entry          8471.93  CFC-113..................  2.7758
     value  $1,000.
    Magnetic disk drive units for a          8471.93.10  CFC-113..................  4.0067
     disk of a diameter over 21 cm (8\1/
     4\ inches).
    Power supplies.....................      8471.99.30  CFC-113..................  0.0655
    Electronic office machines.........            8472  CFC-113..................  0.001
    Populated cards for digital
     processing units in subheading
     8471.91 w/value:
        Not  $100K..........         8473.30  CFC-113..................  0.1408
         $100K..............         8473.30  CFC-113..................  4.82
    Automatic goods-vending machines            8476.11  CFC-12...................  0.45
     with refrigerating device.
    Microwave ovens with electronic             8516.50  .........................  ............................
     controls, with capacity of.
        0.99 cu. ft. or less...........  ..............  CFC-113..................  0.0300
        1.0 through 1.3 cu. ft.........  ..............  CFC-113..................  0.0441
        1.31 cu. ft. or greater........  ..............  CFC-113..................  0.0485
    Microwave oven combinations with      8516.60.40.60  CFC-113..................  0.0595
     electronic controls.
    Telephone sets w/entry value:
        Not  $11.00.........         8517.10  CFC-113..................  0.0225
         $11.00.............         8517.10  CFC-113..................  0.1
    Teleprinters and teletypewriters...         8517.20  CFC-113..................  0.1
    Switching equipment not included in         8517.30  CFC-113..................  0.1267
     subheading 8517.30.20.
    Private branch exchange switching        8517.30.20  CFC-113..................  0.0753
     equipment.
    Modems.............................         8517.40  CFC-113..................  0.0225
    Intercoms..........................         8517.81  CFC-113..................  0.0225
    Facsimile machines.................         85l7.82  CFC-113..................  0.0225
    Loudspeakers, microphones,                     8518  CFC-113..................  0.0022
     headphones, and electric sound
     amplifier sets, not included in
     subheading 8518.30.10.
    Telephone handsets.................      8518.30.10  CFC-113..................  0.042
    Turntables, record players,                    8519  CFC-113..................  0.0022
     cassette players, and other sound
     reproducing apparatus.
    Magnetic tape recorders and other              8520  CFC-113..................  0.0022
     sound recording apparatus, not
     included in subheading 8520.20.
    Telephone answering machines.......         8520.20  CFC-113..................  0.1
    Color video recording/reproducing     8521.10.00.20  CFC-113..................  0.0586
     apparatus.
    Videodisc players..................         8521.90  CFC-113..................  0.0106
    Cordless handset telephones........      8525.20.50  CFC-113..................  0.1
    Cellular communication equipment...      8525.20.60  CFC-113..................  0.4446
    TV cameras.........................         8525.30  CFC-113..................  1.423
    Camcorders.........................         8525.30  CFC-113..................  0.0586
    Radio combinations.................         8527.11  CFC-113..................  0.0022
    Radios.............................         8527.19  CFC-113..................  0.0014
    Motor Vehicle radios with or w/o            8527.21  CFC-113..................  0.0021
     tape player.
    Radio combinations.................         8527.31  CFC-113..................  0.0022

[[Page 29]]

 
    Radios.............................         8527.32  CFC-113..................  0.0014
    Tuners w/o speaker.................   8527.39.00.20  CFC-113..................  0.0022
    Television receivers...............            8528  CFC-113..................  0.0386
    VCRs...............................      8528.10.40  CFC-113..................  0.0586
    Home satellite earth stations......   8528.10.80.55  CFC-113..................  0.0106
    Electronic assemblies for HTS               8529.90  CFC-113..................  0.0816
     headings 8525, 8527, & 8528.
    Indicator panels incorporating              8531.20  CFC-113..................  0.0146
     liquid crystal devices or light
     emitting diodes.
    Printed circuits...................            8534  CFC-113..................  0.001
    Computerized numerical controls....   8537.10.00.30  CFC-113..................  0.1306
    Diodes, crystals, transistors and              8541  CFC-113..................  0.0001
     other similar discrete
     semiconductor devices.
    Electronic integrated circuits and             8542  CFC-113..................  0.0002
     microassemblies.
    Signal generators..................         8543.20  CFC-113..................  0.6518
    Avionics...........................      8543.90.40  CFC-113..................  0.915
    Signal generators subassemblies....      8543.90.80  CFC-113..................  0.1265
    Insulated or refrigerated railway              8606  CFC-11...................  \1\100.
     freight cars.
    Passenger automobiles..............            8703  .........................  ............................
        Foams (interior)...............  ..............  CFC-11...................  0.8
        Foams (exterior)...............  ..............  CFC-11...................  0.7
        With charged a/c...............  ..............  CFC-12...................  2.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.5
    Light trucks.......................            8704  .........................  ............................
        Foams (interior)...............  ..............  CFC-11...................  0.6
        Foams (exterior)...............  ..............  CFC-11...................  0.1
        With charged a/c...............  ..............  CFC-12...................  2.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.4
    Heavy trucks and tractors, GVW                 8704  .........................  ............................
     33,001 lbs or more: \2\.
        Foams (interior)...............  ..............  CFC-11...................  0.6
        Foams (exterior)...............  ..............  CFC-11...................  0.1
        With charged a/c...............  ..............  CFC-12...................  3.0
        Without charged a/c............  ..............  CFC-12...................  0.2
        Electronics....................  ..............  CFC-113..................  0.4
    Motorcycles with seat foamed with              8711  CFC-11...................  0.04
     ODCs.
    Bicycles with seat foamed with ODCs            8712  CFC-11...................  0.04
    Seats foamed with ODCs.............         8714.95  CFC-11...................  0.04
    Aircraft...........................            8802  CFC-12...................  0.25 lb/1000 lbs Operating
                                                                                     Empty Weight (OEW).
                                         ..............  CFC-113..................  30.0 lbs./1000 lbs.OEW
    Optical fibers.....................            9001  CFC-12...................  0.005 lb/thousand feet.
    Electronic cameras.................            9006  CFC-113..................  0.01
    Photocopiers.......................            9009  CFC-113..................  0.0426
    Avionics...........................         9014.20  CFC-113..................  0.915
    Electronic drafting machines.......            9017  CFC-113..................  0.12
    Complete patient monitoring systems      9018.19.80  CFC-12...................  0.94
                                                         CFC-113..................  3.4163
    Complete patient monitoring           9018.19.80.60  CFC-113..................  1.9320
     systems; subassemblies thereof.
    Physical or chemical analysis                  9027  CFC-12...................  0.0003
     instruments.                                        CFC-113..................  0.0271
    Oscilloscopes......................            9030  CFC-11...................  0.49
                                                         CFC-12...................  0.5943
                                                         CFC-113..................  0.2613
    Foam chairs........................            9401  CFC-11...................  0.30
    Foam sofas.........................            9401  CFC-11...................  0.75
    Foam mattresses....................         9404.21  CFC-11...................  1.60
    Electronic games and electronic                9504  CFC-113..................  ............................
     components thereof.
Electronic items not otherwise listed
 in the Table:
    Included in HTS chapters 84, 85, 90  ..............  CFC-113..................  0.0004 pound/$1.00 of entry
                                                                                     value.
    Not included in HTS chapters 84,     ..............  CFC-113..................  0.0004 pound/$1.00 of entry
     85, 90 \3\.                                                                     value.
 
PART III--Products that are not
 Imported Taxable Products:
    Room air conditioners..............   8415.10.00.60  .........................  ............................
    Dishwashers........................         8422.11  .........................  ............................
    Clothes washers....................         8450.11  .........................  ............................
    Clothes dryers.....................         8451.21  .........................  ............................
    Floppy disk drive units............         8471.93  .........................  ............................

[[Page 30]]

 
    Transformers and inductors.........            8504  .........................  ............................
    Toasters...........................         8516.72  .........................  ............................
    Unrecorded media...................            8523  .........................  ............................
    Recorded media.....................            8524  .........................  ............................
    Capacitors.........................            8532  .........................  ............................
    Resistors..........................            8533  .........................  ............................
    Switching apparatus................            8536  .........................  ............................
    Cathode tubes......................            8540  .........................  ............................
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (e)(3)(ii)(C) of this section. Denotes an ODC used in the manufacture of rigid foam
  insulation.
\2\ See paragraph (f)(2)(ii)(A) of this section. Denotes product for which the effective date is October 1,
  1990.
\3\ See paragraph (f)(2)(ii)(B) of this section. Denotes products for which the effective date is January 1,
  1992.

    (g) Requests for modification of Table--(1) In general. Any 
manufacturer or importer of a product may request that the Secretary 
modify the Table in any of the following respects:
    (i) Adding a product to the Table and specifying its Table ODC 
weight.
    (ii) Removing a product from the Table.
    (iii) Changing or specifying the Table ODC weight of a product.
    (2) Form of request. The Secretary will consider a request for 
modification that includes the following:
    (i) The name, address, taxpayer identifying number, and principal 
place of business of the requester.
    (ii) For each product with respect to which a modification is 
requested:
    (A) The name of the product;
    (B) The HTS heading or subheading;
    (C) The type of modification requested;
    (D) The Table ODC weight that should be specified for the product if 
the request relates to adding a product or changing or specifying its 
Table ODC weight; and
    (E) The data supporting the request.
    (3) Address. The address for submission of requests under this 
paragraph (g) is: Internal Revenue Service, P.O. Box 7604, Ben Franklin 
Station, Attn: CC:CORP:T:R (Imported Products Table), room 5228, 
Washington, DC 20044.
    (4) Public inspection and copying. Requests submitted under this 
paragraph (g) will be available in the Internal Revenue Service Freedom 
of Information Reading Room for public inspection and copying.

[T.D. 8370, 56 FR 56311, Nov. 4, 1991, as amended by T.D. 8370, 58 FR 
14518, Mar. 18, 1993]



Sec. 52.4682-4  Floor stocks tax.

    (a) Overview. This section provides rules for identifying ozone-
depleting chemicals (ODCs) that are subject to the floor stocks tax 
imposed by section 4682(h)(1), determining the person that is liable for 
the tax, and computing the amount of the tax. See Sec. 52.4681-1(a)(3) 
and (c) for general rules and definitions relating to the floor stocks 
tax.
    (b) Identifying rules--(1) ODCs subject to floor stocks tax; ODCs 
held for sale or for use in further manufacture--(i) In general. The 
floor stocks tax is imposed only on an ODC that is held for sale or for 
use in further manufacture on the date the tax is imposed. This 
paragraph (b)(1) provides rules for identifying ODCs held for sale or 
for use in further manufacture.
    (ii) Held for sale--(A) In general. For purposes of determining 
whether an ODC is held for sale, the term sale shall have the meaning 
set forth in Sec. 52.4681-1(c)(6). ODCs held for sale include ODCs that 
will be sold in connection with the provision of services or in 
connection with the sale of a manufactured article and, in such cases, 
include ODCs that will be sold without the statement of a separate 
charge for those ODCs.
    (B) ODCs held by a government. An ODC that is held by a government 
for its own use is not held for sale even if the ODC will be transferred 
between agencies or other subdivisions that have or are required to have 
different employer identification numbers.
    (iii) Held for use in further manufacture. Except as otherwise 
provided in paragraph (b)(2)(v) of this section, an ODC is held for use 
in further manufacture if--
    (A) The ODC will be used as a material (within the meaning of 
paragraph

[[Page 31]]

(b)(1)(iv) of this section) in the manufacture of an article; and
    (B) Such article will be held for sale.
    (iv) Use as material--(A) In general. Except as provided in 
paragraph (b)(1)(iv)(B) of this section, an ODC will be used as a 
material in the manufacture of an article if the ODC will be--
    (1) Incorporated into the article; or
    (2) Released into the atmosphere in the process of manufacturing the 
article.
    (B) ODCs used in equipment. For purposes of the floor stocks tax, an 
ODC is not used as a material in the manufacture of an article if the 
ODC is (or will be) contained in equipment used in such manufacture and 
the ODC will be used for its intended purpose without being released 
from such equipment. Thus, ODCs that are (or will be) used as coolants 
in a factory's air-conditioning system are not used as materials in the 
manufacture of articles produced in the factory.
    (v) Storage containers. The floor stocks tax is imposed on an ODC 
without regard to the type or size of the storage container in which the 
ODC is held. Thus, the tax may apply to an ODC whether it is in a 14-
ounce can or a 30-pound tank.
    (vi) Examples. The provisions of this paragraph (b)(1) may be 
illustrated by the following examples:

    Example 1. A, a manufacturer of air conditioners, holds an ODC for 
use in air conditioners that it will manufacture and sell. A holds the 
ODC for use in further manufacture.
    Example 2. B, a manufacturer of electronic components, holds an ODC 
for use as a solvent to clean printed circuits that it will sell to 
computer manufacturers. B holds the ODC for use in further manufacture.
    Example 3. C, an automobile dealer, holds an ODC for use in charging 
air conditioners installed in automobiles that it sells to retail 
customers. C does not hold the ODC for use in further manufacture. C 
does, however, hold the ODC for sale, even if the customers are not 
separately charged for ODCs used in the automobile air conditioners.
    Example 4. D operates an air-conditioning repair service and holds 
an ODC for use in repairing air conditioners for its customers. D holds 
the ODC for sale even if the customers are not separately charged for 
ODCs used in the repairs.
    Example 5. E, a grocery-store chain, holds an ODC for use in its 
refrigeration units. E does not hold the ODC for sale or for use in 
further manufacture.
    Example 6. F, a bank, holds an ODC for use in its fire extinguishers 
to protect the computer system. F does not hold the ODC for sale or for 
use in further manufacture.
    Example 7. G, a government agency, holds an ODC for use in the 
refrigeration equipment of its various units. The units have separate 
employer identification numbers. The ODC is stored in a central 
warehouse until needed by a unit and then transferred to the unit upon 
request. G does not hold the ODC for sale or for use in further 
manufacture.

    (2)(i) Mixtures--(A) Tax imposed on January 1, 1990. In the case of 
the floor stocks tax imposed on January l, 1990, the tax is not imposed 
on an ODC that has been mixed with any other ingredients.
    (B) Taxes imposed after 1990--(1) In general. In the case of the 
floor stocks tax imposed on January 1 of a calendar year after 1990, the 
tax is not imposed on an ODC that has been mixed with any other 
ingredients, but only if it is established that such ingredients 
contribute to the accomplishment of the purpose for which the mixture 
will be used. A mixture is not exempt from tax under this paragraph 
(b)(2)(i)(B), however, if it contains only an ODC and an inert 
ingredient that does not contribute to the accomplishment of the purpose 
for which the mixture will be used.
    (2) Exception. In the case of a floor stocks tax imposed on or after 
January 1, 1992, a mixture is not exempt from floor stocks tax under 
this paragraph (b)(2)(i)(B) if it contains only ODCs and one or more 
stabilizers. For this purpose, the term stabilizer means an ingredient 
needed to maintain the chemical integrity of the ODC.
    (C) Examples. The provisions of this paragraph (b)(2)(i) may be 
illustrated by the following examples:

    Example 1. The floor stocks tax is not imposed on the ODCs contained 
in refrigerants such as R-500 and R-502 because such products are 
mixtures of ODCs and other chemicals that contribute to the 
accomplishment of the purpose for which the mixture will be used.
    Example 2. The floor stocks tax is not imposed on the ODCs contained 
in automotive products used for checking for leaks because such products 
are a mixture of ODCs and

[[Page 32]]

small amounts of dyes and oils that contribute to the accomplishment of 
the purpose for which the mixture will be used.
    Example 3. The floor stocks tax is not imposed on Halon 1301 
pressurized with nitrogen. Although nitrogen is an inert ingredient, it 
contributes to the accomplishment of the purpose for which the mixture 
will be used.
    Example 4. On January 1, 1993, the floor stocks tax is imposed on 
methyl chloroform that is stabilized to prevent hydrolization or 
chemical reaction during transportation or use, unless the stabilized 
methyl chloroform has also been mixed with other ingredients that 
contribute to the accomplishment of the purpose for which the mixture 
will be used.

    (ii) Manufactured articles. The floor stocks tax is not imposed on 
an ODC that is contained in a manufactured article in which the ODC will 
be used for its intended purpose without being released from such 
article. For example, the tax is not imposed on the ODCs contained in 
the cooling coils of a refrigerator even if the refrigerator is held for 
sale. However, the tax is imposed on a can of ODC used to recharge an 
air conditioning unit because the ODC must be expelled from the can in 
order to be used. Similarly, beginning in 1991, the tax is imposed on 
Halons contained in a fire extinguisher held for sale because such ODCs 
must be expelled from the fire extinguisher in order to be used.
    (iii) Recycled ODCs. The floor stocks tax is not imposed on ODCs 
that have been reclaimed or recycled. For example, the tax is not 
imposed on an ODC that is held for use in further manufacture after 
being used as a solvent and recycled.
    (iv) ODCs held by the manufacturer or importer. The floor stocks tax 
is not imposed on ODCs held by their manufacturer or importer.
    (v) ODCs used as a feedstock--(A) In general. The floor stocks tax 
is not imposed on any ODC that was sold in a qualifying sale for use as 
a feedstock (as defined in Sec. 52.4682-1(c)).
    (B) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold 
before January 1, 1991. A post-1989 ODC that was sold by its 
manufacturer or importer before January 1, 1990, or a post-1990 ODC that 
was sold by its manufacturer or importer before January 1, 1991, shall 
be treated, for purposes of this paragraph (b)(2)(v), as an ODC that was 
sold in a qualifying sale for purposes of Sec. 52.4682-1(c) if the ODC 
will be used as a feedstock (within the meaning of Sec. 52.4682-
2(c)(3)).
    (vi) ODCs to be exported--(A) In general. The floor stocks tax is 
not imposed on any ODC that was sold in a qualifying sale for export (as 
defined in Sec. 52.4682-5(d)(1)).
    (B) ODCs sold before January 1, 1993. An ODC that was sold by its 
manufacturer or importer before January 1, 1993, is treated, for 
purposes of this paragraph (b)(2)(vi), as an ODC that was sold in a 
qualifying sale for export for purposes of Sec. 52.4682-5(d)(1) if the 
ODC will be exported.
    (vii) ODCs used as propellants in metered-dose inhalers; years after 
1992--(A) In general. The floor stocks tax is not imposed on January 1 
of calendar years after 1992 on any ODC that was sold in a qualifying 
sale for use as a propellant in a metered-dose inhaler (as defined in 
Sec. 52.4682-1(h)).
    (B) ODCs sold before January 1, 1993. An ODC that was sold by its 
manufacturer or importer before January 1, 1993, is treated, for 
purposes of this paragraph (b)(2)(vii), as an ODC that was sold in a 
qualifying sale for purposes of Sec. 52.4682-1(h) if the ODC will be 
used as a propellant in a metered-dose inhaler (within the meaning of 
Sec. 52.4682-1(h)).
    (viii) ODCs used as medical sterilants; 1993. The floor stocks tax 
is not imposed in 1993 on any ODC held for use as a medical sterilant 
(as defined in Sec. 52.4682-1(g)).
    (c) Person liable for tax--(1) In general. The person liable for the 
floor stocks tax on an ODC is the person that holds the ODC on a date on 
which the tax is imposed. The person who holds the ODC is the person who 
has title to the ODC (whether or not delivery to such person has been 
made) as of the first moment of such date. The person who has title at 
such time is determined under applicable local law.
    (2) Special rule. Each business unit that has, or is required to 
have, its own employer identification number is treated as a separate 
person for purposes of the floor stocks tax. For example, a chain of 
automotive parts stores that has one employer identification

[[Page 33]]

number is one person for purposes of the floor stocks tax, and a parent 
corporation and subsidiary corporation that each have a different 
employer identification number are two persons for purposes of the floor 
stocks tax.
    (d) Computation of tax; tentative tax amount--(1) In general--(i) 
Generally applicable rules. This paragraph (d) provides rules for 
determining the tentative tax amount and the amount of the floor stocks 
tax. Section 52.4681-1(a)(3) provides that the amount of the floor 
stocks tax on an ODC is determined by reference to a tentative tax 
amount. The tentative tax amount is the amount of tax that would be 
imposed on the ODC under section 4681(a)(1) if a sale of the ODC by the 
manufacturer or importer had occurred on the date the floor stocks tax 
is imposed. The amount of the floor stocks tax imposed on the ODCs 
contained in a nonexempt mixture is computed on the basis of the weight 
of the ODCs in that mixture.
    (ii) Floor stocks tax imposed on post-1989 ODCs on January 1, 1990. 
The floor stocks tax imposed on post-1989 ODCs (as defined in Sec. 
52.4681-1(c)(9)) on January 1, 1990, is equal to the tentative tax 
amount. See paragraph (d)(2) of this section for rules relating to the 
floor stocks tax imposed on ODCs used in the manufacture of rigid foam 
insulation. See paragraph (d)(3) of this section for rules relating to 
the floor stocks tax imposed on Halons.
    (iii) Floor stocks tax imposed on post-1990 ODCs on January 1, 1991. 
The floor stocks tax imposed on post-1990 ODCs (as defined in Sec. 
52.4681-1(c)(9)) on January 1, 1991, is equal to the tentative tax 
amount.
    (iv) Other floor stocks taxes--(A) In general. The following rules 
apply for floor stocks taxes imposed on post-1989 ODCs after January 1, 
1990, and on post-1990 ODCs after January 1, 1991:
    (1) The tentative tax amount is determined, except as provided in 
paragraph (d)(2), (3), or (4) of this section, by reference to the rate 
of tax prescribed in section 4681(b)(1)(B) and the ozone-depletion 
factors prescribed in section 4682(b).
    (2) The amount of the floor stocks tax on an ODC is equal to the 
amount by which the tentative tax amount exceeds the amount of taxes 
previously imposed on the ODC.
    (B) Example. The application of this paragraph (d)(1)(iv) may be 
illustrated by the following example:

    Example. The floor stocks tax imposed on one pound of CFC-12 held 
for sale on January 1, 1992, is $0.30 (the amount by which $1.67, the 
tentative tax, exceeds $1.37, the tax previously imposed on CFC-12).

    (2) ODCs used in the manufacture of rigid foam insulation; 1990, 
1991, 1992, and 1993--(i) In general. In the case of an ODC that was 
sold in a qualifying sale for purposes of Sec. 52.4682-1(d) (relating 
to use in the manufacture of rigid foam insulation) the tentative tax 
amount is determined under section 4682(g) for purposes of computing the 
floor stocks tax imposed on the ODC on January 1, 1990, 1991, 1992 or 
1993. For purposes of computing the floor stocks tax imposed on the ODC 
on January 1, 1990, the tentative tax amount is zero. The floor stocks 
tax is not imposed on ODCs for use in the manufacture of rigid foam 
insulation in 1992 and 1993.
    (ii) Post-1989 ODCs sold before January 1, 1990; post-1990 ODCs sold 
before January 1, 1991. A post-1989 ODC that was sold by its 
manufacturer or importer before January 1, 1990, or a post-1990 ODC that 
was sold by its manufacturer or importer before January 1, 1991, shall 
be treated, for purposes of paragraphs (d)(2) and (e) of this section, 
as an ODC that was sold in a qualifying sale for purposes of Sec. 
52.4682-1(d) if the ODC wi11 be used in the manufacture of rigid foam 
insulation (within the meaning of Sec. Sec. 52.4682-1(d) (3) and (4)).
    (3) Halons; 1990, 1991, 1992, and 1993. In the case of Halon-1211, 
Halon-1301, or Halon-2402 (Halons), the tentative tax amount is 
determined under section 4682(g) for purposes of computing the floor 
stocks tax imposed on Halons on January 1, 1990, 1991, 1992, or 1993. 
For purposes of computing the floor stocks tax imposed on Halons on 
January 1, 1990, the tentative tax amount is zero. The floor stocks tax 
is not imposed on Halons in 1992 and 1993.
    (4) Methyl chloroform; 1993. In the case of methyl chloroform, the 
tentative tax amount is determined under section 4682(g)(5) for purposes 
of computing the floor stocks tax imposed on January 1, 1993.

[[Page 34]]

    (e) De minimis exception--(1) 1990 and 1992. In the case of the 
floor stocks tax imposed on January 1, 1990 or 1992, a person is liable 
for the tax only if, on the date the tax is imposed, the person holds at 
least 400 pounds of post-1989 ODCs that are not described in paragraph 
(d) (2) or (3) of this section and are otherwise subject to tax.
    (2) 1991. In the case of the floor stocks tax imposed on January 1, 
1991, a person is liable for the tax only if, on such date, the person 
holds at least 400 pounds of ODCs subject to the 1991 floor stocks tax. 
For this purpose, ODCs subject to the 1991 floor stocks tax are--
    (i) Post-1990 ODCs that are subject to tax; and
    (ii) Post-1989 ODCs that are described in paragraph (d) (2) or (3) 
of this section and are otherwise subject to tax.
    (3) 1993. In the case of the floor stocks tax imposed on January 1, 
1993, a person is liable for the tax only if, on such date, the person 
holds at least 400 pounds of ODCs that are not described in paragraph 
(d) (2) or (3) of this section and are otherwise subject to tax.
    (4) 1994. In the case of the floor stocks tax imposed on January 1, 
1994, a person is liable for the tax only if, on such date, the person 
holds--
    (i) At least 400 pounds of ODCs that are not described in paragraph 
(d)(2) or (d)(3) of this section and are otherwise subject to tax;
    (ii) At least 200 pounds of ODCs that are described in paragraph 
(d)(2) of this section and are otherwise subject to tax; or
    (iii) At least 20 pounds of ODCs that are described in paragraph 
(d)(3) of this section and are otherwise subject to tax.
    (5) Calendar years after 1994. In the case of the floor stocks tax 
imposed on January 1 of 1995 and each following calendar year, a person 
is liable for the tax only if, on such date, the person holds--
    (i) At least 400 pounds of ODCs that are not described in paragraph 
(d)(3) or (d)(4) of this section and are otherwise subject to tax;
    (ii) At least 50 pounds of ODCs that are described in paragraph 
(d)(3) of this section and are otherwise subject to tax; or
    (iii) At least 1000 pounds of ODCs that are described in paragraph 
(d)(4) of this section and are otherwise subject to tax.
    (6) Examples. The rules of this paragraph (e) may be illustrated by 
the following examples:

    Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12 
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section)) and 500 pounds of R-500 (a mixture). A does not hold at least 
400 pounds of ODCs that are taken into account under paragraph (e)(1) of 
this section and, under paragraph (b)(2)(i) of this section, mixtures 
are not subject to the floor stocks tax. Thus, A is not liable for the 
floor stocks tax imposed on January 1, 1990.
    Example 2. On January 1, 1990, B holds for sale 250 pounds of CFC-12 
and 250 pounds of CFC-113 (post-1989 ODCs not described in paragraph (d) 
(2) or (3) of this section). B holds 500 pounds of ODCs that are taken 
into account under paragraph (e)(1) of this section. Thus, B is liable 
for the floor stocks tax imposed on January 1, 1990, because B holds at 
least 400 pounds of ODCs for sale.
    Example 3. On January 1, 1990, C holds 200 pounds of post-1990 ODCs 
and 500 pounds of post-1989 ODCs for use in further manufacture. C will 
use 300 pounds of the post-1989 ODCs in the manufacture of rigid foam 
insulation (as defined in Sec. 52.4682-1(d) (3) and (4)). The remainder 
of the ODCs are not described in paragraph (d) (2) or (3) of this 
section. Under paragraph (e)(1) of this section, post-1990 ODCs and ODCs 
that will be used in the manufacture of rigid foam insulation are 
disregarded in determining whether the de minimis exception is 
applicable in 1990. Thus, C holds only 200 pounds of ODCs that are taken 
into account under paragraph (e)(1) of this section and is not liable 
for the floor stocks tax imposed on January 1, 1990.
    Example 4. (a) The facts are the same as in Example 3, except that 
the ODCs are held on January 1, 1991. Under paragraph (e)(2) of this 
section, the 200 pounds of post-1990 ODCs and the 300 pounds of post-
1989 ODCs that will be used in the manufacture of rigid foam insulation 
are taken into account in determining whether the de minimis exception 
is applicable in 1991. Under paragraph (b)(2) of this section, the 
remaining 200 pounds of post-1989 ODCs are not taken into account 
because the base tax amount applicable to post-1989 ODCs does not 
increase in 1991. Thus, C holds 500 pounds of ODCs that are taken into 
account under paragraph (e)(2) of this section and is liable for the 
floor stocks tax imposed on January 1, 1991.
    (b) The amount of the floor stocks tax imposed on the 200 pounds of 
post-1990 ODCs and the 300 pounds of post-1989 ODCs that will be used in 
the manufacture of rigid foam

[[Page 35]]

insulation is equal to the tentative tax amount because those ODCs were 
not previously subject to tax.
    Example 5. (a) On January 1, 1994, D holds for sale 300 pounds of 
CFC-113 (an ODC not described in paragraph (d)(2) or (d)(3) of this 
section) and 25 pounds of Halon-1301 (an ODC described in paragraph 
(d)(3) of this section). D is liable for the floor stocks tax imposed on 
January 1, 1994, because 25 pounds of Halon-1301 exceeds the de minimis 
amount specified in paragraph (e)(4)(iii) of this section. The 300 
pounds of CFC-113 is less than the amount specified in paragraph 
(e)(4)(i) of this section. Nevertheless, tax is imposed on both the 25 
pounds of Halon-1301 and the 300 pounds of CFC-113.
    (b) The amount of the floor stocks tax is determined separately for 
the 300 pounds of CFC-113 and the 25 pounds of Halon-1301 and is equal 
to the difference between the tentative tax amount and the amount of tax 
previously imposed on those ODCs. For Halon-1301, for example, the tax 
is determined as follows. The tentative tax amount is $1,087.50 ($4.35 
(the base tax amount in 1994) x 10 (the ozone-depletion factor for 
Halon-1301) x 25 (the number of pounds held)). The tax previously 
imposed on the Halon-1301 is $6.28 ($3.35 (the base tax amount in 1993) 
x 10 (the ozone-depletion factor for Halon-1301) x 0.75 percent (the 
applicable percentage determined under section 4682(g)(2)(A)) x 25 (the 
number of pounds held)). Thus, the floor stocks tax imposed on the 25 
pounds of Halon-1301 in 1994 is $1,081.22, the difference between 
$1,087.50 (the tentative tax amount) and $6.28 (the tax previously 
imposed).

    (f) Inventory--(1) In general. If, on the date on which the floor 
stocks tax is imposed, a person holds ODCs for sale or for use in 
further manufacture and the ODCs were not manufactured or imported by 
such person, the following rules apply:
    (i) The person shall prepare an inventory of all such ODCs that the 
person holds on the date on which the tax is imposed.
    (ii) The inventory shall be taken as of the first moment of the date 
on which the tax is imposed, but work-back or work-forward inventories 
will be acceptable if supported by adequate commercial records of 
receipt, use, and disposition of ODCs held for sale or for use in 
further manufacture.
    (iii) The person must maintain records of the inventory and make 
such records available for inspection and copying by internal revenue 
agents and officers. Records of the inventory are not to be filed with 
the Internal Revenue Service.
    (2) Circumstances in which an inventory is not required. The 
inventory requirement of paragraph (f)(1) of this section does not apply 
to any person holding, on a date on which floor stocks tax is imposed, 
only ODCs that are not subject to tax by reason of a statutory exemption 
(e.g., use as a feedstock) or regulatory exclusion other than the de 
minimis exception provided by paragraph (e) of this section (e.g., 
mixtures). In addition, any person that holds ODCs subject to the floor 
stocks tax and also holds ODCs that are nontaxable under the provisions 
of paragraph (b)(2) of this section, is not required to inventory the 
nontaxable ODCs. However, any person that holds any ODCs that either are 
subject to the floor stocks tax or would be subject to the floor stocks 
tax but for the de minimis exception must inventory those ODCs.
    (3) Examples. The rules of this paragraph (f) may be illustrated by 
the following examples:

    Example 1. On January 1, 1990, A holds for sale 300 pounds of CFC-12 
(a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section) and 500 pounds of R-500 (a mixture). As required by paragraph 
(f)(1) of this section, A must prepare an inventory of the CFC-12 A 
holds for sale on that date even though, under paragraph (e)(1) of this 
section, the 300 pounds of CFC-12 is not taken into account because it 
is de minimis. However, as provided in paragraph (f)(2) of this section, 
A is not required to inventory the R-500 because, under paragraph (b)(2) 
of this section, mixtures are not subject to the floor stocks tax.
    Example 2. On January 1, 1991, B holds for sale 1,000 pounds of CFC-
12 (a post-1989 ODC not described in paragraph (d)(2) or (d)(3) of this 
section). As provided under paragraph (f)(2) of this section, B is not 
required to prepare an inventory because CFC-12 is not subject to the 
floor stocks tax in 1991.

    (g) Time for paying tax. The floor stocks tax imposed under section 
4682(h) shall be paid without assessment or notice. In the case of the 
floor stocks tax imposed on January 1, 1990, the tax shall be paid by 
April 1, 1990. In the case of floor stocks taxes imposed after January 
1, 1990, the tax shall be

[[Page 36]]

paid by June 30 of the year in which the tax is imposed.

[T.D. 8370, 56 FR 56317, Nov. 4, 1991, as amended by T.D. 8622, 60 FR 
52852, Oct. 11, 1995]



Sec. 52.4682-5  Exports.

    (a) Overview. This section provides rules relating to the tax 
imposed under section 4681 on ozone-depleting chemicals (ODCs) that are 
exported. In general, tax is not imposed on ODCs that a manufacturer or 
importer sells for export, or for resale by the purchaser to a second 
purchaser for export, if the procedural requirements set forth in 
paragraph (d) of this section are met. The tax benefit of this exemption 
is limited, however, to the manufacturer's or importer's exemption 
amount. Thus, if the tax that would otherwise be imposed under section 
4681 on ODCs that a manufacturer or importer sells for export exceeds 
this exemption amount, a tax equal to the excess is imposed on the ODCs. 
The exemption amount, which is determined separately for post-1989 ODCs 
and post-1990 ODCs, is calculated for each calendar year in accordance 
with the rules of paragraph (c) of this section. This section also 
provides rules under which a tax imposed under section 4681 on exported 
ODCs may be credited or refunded, subject to the same limit on tax 
benefits, if the procedural requirements set forth in paragraph (f) of 
this section are met. See Sec. 52.4681-1(c) for definitions relating to 
the tax on ODCs.
    (b) Exemption or partial exemption from tax--(1) In general. Except 
as provided in paragraph (b)(2) of this section, no tax is imposed on an 
ODC if the manufacturer or importer of the ODC sells the ODC in a 
qualifying sale for export (within the meaning of paragraph (d)(1) of 
this section).
    (2) Tax imposed if exemption amount exceeded--(i) Post-1989 ODCs. 
The tax imposed on post-1989 ODCs that a manufacturer or importer sells 
in qualifying sales for export during a calendar year is equal to the 
excess (if any) of--
    (A) The tax that would be imposed on the ODCs but for section 
4682(d)(3) and this section; over
    (B) The post-1989 ODC exemption amount for the calendar year 
determined under paragraph (c)(1) of this section.
    (ii) Post-1990 ODCs. The tax imposed on post-1990 ODCs that a 
manufacturer or importer sells in qualifying sales for export during a 
calendar year is equal to the excess (if any) of--
    (A) The tax that would be imposed on the ODCs but for section 
4682(d)(3) and this section; over
    (B) The post-1990 ODC exemption amount for the calendar year 
determined under paragraph (c)(2) of this section.
    (iii) Allocation of tax--(A) Post-1989 ODCs. The tax (if any) 
determined under paragraph (b)(2)(i) of this section may be allocated 
among the post-1989 ODCs on which it is imposed in any manner, provided 
that the amount allocated to any post-1989 ODC does not exceed the tax 
that would be imposed on such ODC but for section 4682(d)(3) and this 
section.
    (B) Post-1990 ODCs. The tax (if any) determined under paragraph 
(b)(2)(ii) of this section may be allocated among the post-1990 ODCs on 
which it is imposed in any manner, provided that the amount allocated to 
any post-1990 ODC does not exceed the tax that would be imposed on such 
ODC but for section 4682(d)(3) and this section.
    (c) Exemption amount--(1) Post-1989 ODC exemption amount. A 
manufacturer's or importer's post-1989 ODC exemption amount for a 
calendar year is the sum of the following amounts:
    (i) The 1986 export percentage of the aggregate tax that would (but 
for section 4682(d), section 4682(g), and this section) be imposed under 
section 4681 on the maximum quantity, determined without regard to 
additional production allowances, of post-1989 ODCs that the person is 
permitted to manufacture during the calendar year under rules prescribed 
by the Environmental Protection Agency (40 CFR part 82).
    (ii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1989 
ODCs that the person manufactures during the calendar year under any 
additional production allowance granted by the Environmental Protection 
Agency.
    (iii) The aggregate tax that would (but for section 4682(d), section 
4682(g),

[[Page 37]]

and this section) be imposed under section 4681 on post-1989 ODCs 
imported by the person during the calendar year.
    (2) Post-1990 ODC exemption amount. A manufacturer's or importer's 
post-1990 ODC exemption amount for a calendar year is the sum of the 
following amounts:
    (i) The 1989 export percentage of the aggregate tax that would (but 
for section 4682(d), section 4682(g), and this section) be imposed under 
section 4681 on the maximum quantity, determined without regard to 
additional production allowances, of post-1990 ODCs the person is 
permitted to manufacture during the calendar year under rules prescribed 
by the Environmental Protection Agency.
    (ii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1990 
ODCs that the person manufactures during the calendar year under any 
additional production allowance granted by the Environmental Protection 
Agency.
    (iii) The aggregate tax that would (but for section 4682(d), section 
4682(g), and this section) be imposed under section 4681 on post-1990 
ODCs imported by the person during the calendar year.
    (3) Definitions--(i) 1986 export percentage. See section 
4682(d)(3)(B)(ii) for the meaning of the term 1986 export percentage.
    (ii) 1989 export percentage. See section 4682(d)(3)(C) for the 
meaning of the term 1989 export percentage.
    (d) Procedural requirements relating to tax-free sales for export--
(1) Qualifying sales--(i) In general. A sale of ODCs is a qualifying 
sale for export if--
    (A) The seller is the manufacturer or importer of the ODCs and the 
purchaser is a purchaser for export or for resale to a second purchaser 
for export;
    (B) At the time of the sale, the seller and the purchaser are 
registered with the Internal Revenue Service; and
    (C) At the time of the sale, the seller--
    (1) Has an unexpired certificate in substantially the form set forth 
in paragraph (d)(3)(ii) of this section from the purchaser; and
    (2) Relies on the certificate in good faith.
    (ii) Qualifying resale. A sale of ODCs is a qualifying resale for 
export if--
    (A) The seller acquired the ODCs in a qualifying sale for export and 
the purchaser is a second purchaser for export;
    (B) At the time of the sale, the seller and the purchaser are 
registered with the Internal Revenue Service; and
    (C) At the time of the sale, the seller--
    (1) Has an unexpired certificate in substantially the form set forth 
in paragraph (d)(3)(ii)(A) of this section from the purchaser of the 
ODCs; and
    (2) Relies on the certificate in good faith.
    (iii) Special rule relating to sales made before July 1, 1993. If a 
sale for export made before July 1, 1993, satisfies all the requirements 
of paragraph (d)(1)(i) or (ii) of this section other than those relating 
to registration, the sale will be treated as a qualifying sale (or 
resale) for export. Thus, a sale made before July 1, 1993, may be a 
qualifying sale (or resale) even if the parties to the sale are not 
registered and the required certificate does not contain statements 
regarding registration.
    (iv) Registration. Application for registration is made on Form 637 
(or any other form designated for the same use by the Commissioner) 
according to the instructions applicable to the form. A person is 
registered only if the district director has issued that person a letter 
of registration and it has not been revoked or suspended. The effective 
date of the registration must be no earlier than the date on which the 
district director signs the letter of registration. Each business unit 
that has, or is required to have, a separate employer identification 
number is treated as a separate person.
    (2) Good faith reliance. The requirements of paragraph (d)(1) of 
this section are not satisfied with respect to a sale of ODCs and the 
sale is not a qualifying sale (or resale) if, at the time of the sale--
    (i) The seller has reason to believe that the ODCs are not purchased 
for export; or
    (ii) The Internal Revenue Service has notified the seller that the 
purchaser's registration has been revoked or suspended.

[[Page 38]]

    (3) Certificate--(i) In general. The certificate required under 
paragraph (d)(1) of this section consists of a statement executed and 
signed under penalties of perjury by a person with authority to bind the 
purchaser, in substantially the same form as model certificates provided 
in paragraph (d)(3)(ii) of this section, and containing all information 
necessary to complete such model certificate. A new certificate must be 
given if any information in the current certificate changes. The 
certificate may be included as part of any business records normally 
used to document a sale. The certificate expires on the earliest of the 
following dates--
    (A) The date one year after the effective date of the certificate;
    (B) The date the purchaser provides a new certificate to the seller; 
or
    (C) The date the seller is notified by the Internal Revenue Service 
or the purchaser that the purchaser's registration has been revoked or 
suspended.
    (ii) Model certificates--(A) ODCs sold for export by the purchaser. 
If the purchaser will export the ODCs, the certificate must be in 
substantially the following form:

    CERTIFICATE OF PURCHASER OF CHEMICALS FOR EXPORT BY THE PURCHASER

  (To support tax-free sales under section 4682(d)(3) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not more than one year
 after effective date)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    Purchaser is registered with the Internal Revenue Service as a 
purchaser of ozone-depleting chemicals for export under registration 
number ----------. Purchaser's registration has not been suspended or 
revoked by the Internal Revenue Service.
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)

are purchased for export by Purchaser.

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................   ----------
CFC-12.....................................................   ----------
CFC-113....................................................   ----------
CFC-114....................................................   ----------
CFC-115....................................................   ----------
Halon-1211.................................................   ----------
Halon-1301.................................................   ----------
Halon-2402.................................................   ----------
Carbon tetrachloride.......................................   ----------
Methyl chloroform..........................................   ----------
 Other (specify)
 --------------............................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser understands that Purchaser will be liable for tax imposed 
under section 4681 if Purchaser does not export the ODCs to which this 
certificate applies.

    Purchaser understands that any use of the ODCs to which this 
certificate applies other than for export may result in the revocation 
of Purchaser's registration.

    Purchaser will retain the business records needed to document the 
export of the ozone-depleting chemicals to which this certificate 
applies and will make such records available for inspection by 
Government officers.

    Purchaser has not been notified by the Internal Revenue Service that 
its registration has been revoked or suspended.

    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.

________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________

[[Page 39]]

Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature

    (B) ODCs sold by the purchaser for resale for export by the second 
purchaser. If the purchaser will resell the ODCs to a second purchaser 
for export by the second purchaser, the certificate must be in 
substantially the following form:

   CERTIFICATE OF PURCHASER OF CHEMICALS FOR RESALE FOR EXPORT BY THE 
                            SECOND PURCHASER

  (To support tax-free sales under section 4682(d)(3) of the Internal 
                             Revenue Code.)

Effective Date__________________________________________________________
Expiration Date_________________________________________________________
 (not more than one year
 after effective date)
    The undersigned purchaser (Purchaser) certifies the following under 
penalties of perjury:
    Purchaser is registered with the Internal Revenue Service as a 
purchaser of ozone-depleting chemicals for export under registration 
number ----------. Purchaser's registration has not been suspended or 
revoked by the Internal Revenue Service.
    The following percentage of ozone-depleting chemicals purchased 
from:
________________________________________________________________________
(Name of seller)
________________________________________________________________________
(Address of seller)
________________________________________________________________________
(Taxpayer identifying number of seller)

will be resold by Purchaser to persons (Second Purchasers) that certify 
to Purchaser that they are (1) registered with the Internal Revenue 
Service as purchasers of ozone-depleting chemicals for export and (2) 
purchasing the ozone-depleting chemicals for export.

------------------------------------------------------------------------
                          Product                             Percentage
------------------------------------------------------------------------
CFC-11.....................................................   ----------
CFC-12.....................................................   ----------
CFC-113....................................................   ----------
CFC-114....................................................   ----------
CFC-115....................................................   ----------
Halon-1211.................................................   ----------
Halon-1301.................................................   ----------
Halon-2402.................................................   ----------
Carbon tetrachloride.......................................   ----------
Methyl chloroform..........................................   ----------
 Other (specify)
--------------.............................................   ----------
------------------------------------------------------------------------

    This certificate applies to (check and complete as applicable):

------ All shipments to Purchaser at the following location(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following Purchaser account 
          number(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ All shipments to Purchaser under the following purchase order(s):
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
------ One or more shipments to Purchaser identified as follows:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
    Purchaser understands that Purchaser will be liable for tax imposed 
under section 4681 if Purchaser does not resell the ODCs to which this 
certificate applies to a Second Purchaser for export or export those 
ODCs.
    Purchaser understands that any use of the ODCs to which this 
certificate applies other than for resale to Second Purchasers for 
export may result in the revocation of Purchaser's registration.
    Purchaser will retain the business records needed to document the 
sales to Second Purchasers for export covered by this certificate and 
will make such records available for inspection by Government officers. 
Purchaser also will retain and make available for inspection by 
Government officers the certificates of its Second Purchasers.
    Purchaser has not been notified by the Internal Revenue Service that 
its registration has been revoked or suspended. In addition, the 
Internal Revenue Service has not notified Purchaser of the revocation or 
suspension of the registration of any Second Purchaser who will purchase 
ozone-depleting chemicals to which this certificate applies.
    Purchaser understands that the fraudulent use of this certificate 
may subject Purchaser and all parties making such fraudulent use of this 
certificate to a fine or imprisonment, or both, together with the costs 
of prosecution.
________________________________________________________________________
Name of Purchaser
________________________________________________________________________
Address of Purchaser
________________________________________________________________________
________________________________________________________________________
Taxpayer Identifying Number of Purchaser
________________________________________________________________________
Title of person signing
________________________________________________________________________
Printed or typed name of person signing
________________________________________________________________________
Signature


[[Page 40]]


    (4) Documentation of export--(i) After December 31, 1992. After 
December 31, 1992, to document the exportation of any ODCs, a person 
must have the evidence required by the Environmental Protection Agency 
as proof that the ODCs were exported.
    (ii) Before January 1, 1993. Before January 1, 1993, to document the 
exportation of any ODCs, a person must have evidence substantially 
similar to that required by the Environmental Protection Agency as proof 
that the ODCs were exported.
    (e) Purchaser liable for tax--(1) Purchaser in qualifying sale. The 
purchaser of ODCs in a qualifying sale for export is treated as the 
manufacturer of the ODC and is liable for any tax imposed under section 
4681 (determined without regard to exemptions for qualifying sales under 
this section or Sec. 52.4682-1) when it sells or uses the ODCs if that 
purchaser does not-
    (i) Export the ODCs and document the exportation of the ODCs in 
accordance with paragraph (d)(4) of this section; or
    (ii) Sell the ODCs in a qualifying resale for export.
    (2) Purchaser in qualifying resale. The purchaser of ODCs in a 
qualifying resale for export is treated as the manufacturer of the ODC 
and is liable for any tax imposed under section 4681 (determined without 
regard to exemptions for qualifying sales under this section or Sec. 
52.4682-1) when it sells or uses the ODCs if that purchaser does not 
export the ODCs and document the exportation of the ODCs in accordance 
with paragraph (d)(4) of this section.
    (f) Credit or refund--(1) In general. Except as provided in 
paragraph (f)(2) of this section, a manufacturer or importer that meets 
the conditions of paragraph (f)(3) of this section is allowed a credit 
or refund (without interest) of the tax it paid to the government under 
section 4681 on ODCs that are exported. Persons other than manufacturers 
and importers of ODCs cannot file claims for credit or refund of tax 
imposed under section 4681 on ODCs that are exported.
    (2) Limitation. The amount of credits or refunds of tax under this 
paragraph (f) is limited--
    (i) In the case of tax paid on post-1989 ODCs sold during a calendar 
year, to the amount (if any) by which the post-1989 exemption amount for 
the year exceeds the tax benefit provided to such post-1989 ODCs under 
paragraph (b) of this section; and
    (ii) In the case of tax paid on post-1990 ODCs sold during a 
calendar year, to the amount (if any) by which the post-1990 exemption 
amount for the year exceeds the tax benefit provided to such post-1990 
ODCs under paragraph (b) of this section.
    (3) Conditions to allowance of credit or refund. The conditions of 
this paragraph (f)(3) are met if the manufacturer or importer--
    (i) Documents the exportation of the ODCs in accordance with 
paragraph (d)(4) of this section; and
    (ii) Establishes that it has--
    (A) Repaid or agreed to repay the amount of the tax to the person 
that exported the ODC; or
    (B) Obtained the written consent of the exporter to the allowance of 
the credit or the making of the refund.
    (4) Procedural rules. See section 6402 and the regulations under 
that section for procedural rules relating to filing a claim for credit 
or refund of tax.
    (g) Examples. The following examples illustrate the provisions of 
this section. In each example, the sales are qualifying sales for export 
(within the meaning of paragraph (d)(1) of this section), all 
registration, certification, and documentation requirements of this 
section are met, and the ODCs sold for export are exported:

    Example 1. (i) Facts. D, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, D 
manufactures 100,000 pounds of CFC-11, the maximum quantity D is allowed 
to manufacture in 1993 under EPA regulations. D has no additional 
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is 
$3.35 per pound. D's 1986 export percentage for post-1989 ODCs is 50%. 
In 1993, D sells 80,000 pounds of CFC-11 in qualifying sales for export. 
The remainder of D's production is not exported.
    (ii) Components of limit on tax benefit. Under paragraph (c)(1) of 
this section, D's exemption amount for 1993 is equal to the sum of--
    (A) D's 1986 export percentage multiplied by the aggregate tax that 
would (but for section 4682(d), section 4682(g), and Sec. 52.4682-5) be 
imposed under section 4681 on the maximum

[[Page 41]]

quantity of post-1989 ODCs D is permitted to manufacture during 1993;
    (B) The aggregate tax that would (but for section 4682(d), section 
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989 
ODCs that D manufactures during 1993 under an additional production 
allowance; and
    (C) The aggregate tax that would (but for section 4682(d), section 
4682(g), and Sec. 52.4682-5) be imposed under section 4681 on post-1989 
ODCs imported by D during 1993.
    (iii) Limit on tax benefit. The amounts described in paragraphs 
(ii)(B) and (C) of this Example 1 are equal to zero. Thus, D's 1993 
exemption amount is $167,500 (50% of $335,000 (the tax that would 
otherwise be imposed on 100,000 pounds of CFC-11 in 1993)).
    (iv) Application of limit on tax benefit. Under paragraph (b)(2) of 
this section, the tax imposed on the CFC-11 D sells for export is equal 
to the excess of the tax that would have been imposed on those ODCs but 
for section 4682(d) and Sec. 52.4682-5, over D's 1993 exemption amount. 
But for Sec. 52.4682-5, $268,000 ($3.35 x 80,000) of tax would have 
been imposed on the CFC-11 sold for export. Thus, $100,500 ($268,000 - 
$167,500) of tax is imposed on the CFC-11 sold for export.
    Example 2. (i) Facts. E, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture or import any other ODCs. In 1993, E 
manufactures 100,000 pounds of CFC-11, the maximum quantity E is allowed 
to manufacture in 1993 under EPA regulations. E has no additional 
production allowance from EPA for 1993. In 1993, the tax on CFC-11 is 
$3.35 per pound. E's 1986 export percentage for post-1989 ODCs is 50%. 
In 1993, E sells 45,000 pounds of CFC-11 tax free in qualifying sales 
for export and pays tax under section 4681 on an additional 35,000 
pounds of exported CFC-11. The remainder of E's production is not 
exported.
    (ii) Limit on tax benefit. E's 1993 exemption amount is $167,500, 
(50% of $335,000 (the tax that would otherwise be imposed on 100,000 
pounds of CFC-11 in 1993)). The credit or refund allowed to E under 
paragraph (f) of this section is limited under paragraph (f)(2) of this 
section to the amount by which E's 1993 exemption amount exceeds E's 
1993 tax benefit under paragraph (b) of this section.
    (iii) Application of limit on tax benefit. Because E sold 45,000 
pounds of CFC-11 tax free in qualifying sales for export in 1993, E's 
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35 
x 45,000). Thus, the credit or refund allowed to E under paragraph (f) 
of this section is limited to $16,750 ($167,500-$150,750).
    Example 3. (i) Facts. F, a corporation, manufactures CFC-11, a post-
1989 ODC, and does not manufacture any other ODCs. F also imports CFC-
11. In 1993, F manufactures 60,000 pounds of CFC-11 (100,000 pounds is 
the maximum quantity F is allowed to manufacture in 1993 under EPA 
regulations) and imports 40,000 pounds. F has no additional production 
allowance from EPA for 1993. In 1993, the tax on CFC-11 is $3.35 per 
pound. F's 1986 export percentage for post-1989 ODCs is 50%. In 1993, F 
sells 45,000 pounds of CFC-11 tax free in qualifying sales for export 
and pays tax under section 4681 on an additional 35,000 pounds of 
exported CFC-11. The remainder of F's production is not exported.
    (ii) Limit on tax benefit. F's 1993 exemption amount is $301,500, 
($167,500 (50% of $335,000 (the tax that would otherwise be imposed on 
100,000 pounds of CFC-11 in 1993) plus $134,000 (the tax that would 
otherwise be imposed on the 40,000 pounds imported)). The credit or 
refund allowed to F under paragraph (f) of this section is limited under 
paragraph (f)(2) of this section to the amount by which F's 1993 
exemption amount exceeds F's 1993 tax benefit under paragraph (b) of 
this section.
    (iii) Application of limit on tax benefit. Because F sold 45,000 
pounds of CFC-11 tax free in qualifying sales for export in 1993, F's 
1993 tax benefit under paragraph (b) of this section is $150,750 ($3.35 
x 45,000). Thus, the credit or refund allowed to F under paragraph (f) 
of this section is limited to $150,750 ($301,500-$150,750). The 
limitation does not affect F's credit or refund because the tax F paid 
on exported ODCs is only $117,250 ($3.35 x 35,000).

    (h) Effective date. This section is effective January 1, 1993.

[T.D. 8622, 60 FR 52853, Oct. 11, 1995]



PART 53_FOUNDATION AND SIMILAR EXCISE TAXES--Table of Contents



                  Subpart A_Taxes on Investment Income

Sec.
53.4940-1 Excise tax on net investment income.

                     Subpart B_Taxes on Self-Dealing

53.4941(a)-1 Imposition of initial taxes.
53.4941(b)-1 Imposition of additional taxes.
53.4941(c)-1 Special rules.
53.4941(d)-1 Definition of self-dealing.
53.4941(d)-2 Specific acts of self-dealing.
53.4941(d)-3 Exceptions to self-dealing.
53.4941(d)-4 Transitional rules.
53.4941(e)-1 Definitions.
53.4941(f)-1 Effective dates.

             Subpart C_Taxes on Failure To Distribute Income

53.4942(a)-1 Taxes for failure to distribute income.
53.4942(a)-2 Computation of undistributed income.

[[Page 42]]

53.4942(a)-3 Qualifying distributions defined.
53.4942(b)-1 Operating foundations.
53.4942(b)-2 Alternative tests.
53.4942(b)-3 Determination of compliance with operating foundation 
          tests.

               Subpart D_Taxes on Excess Business Holdings

53.4943-1 General rule; purpose.
53.4943-2 Imposition of tax on excess business holdings of private 
          foundations.
53.4943-3 Determination of excess business holdings.
53.4943-4 Present holdings.
53.4943-5 Present holdings acquired by trust or a will.
53.4943-6 Five-year period to dispose of gifts, bequests, etc.
53.4943-7 Special rules for readjustments involving grandfathered 
          holdings.
53.4943-8 Business holdings; constructive ownership.
53.4943-9 Business holdings; certain periods.
53.4943-10 Business enterprise; definition.
53.4943-11 Effective date.

   Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose

53.4944-1 Initial taxes.
53.4944-2 Additional taxes.
53.4944-3 Exception for program-related investments.
53.4944-4 Special rules.
53.4944-5 Definitions.
53.4944-6 Special rules for investments made prior to January 1, 1970.

                 Subpart F_Taxes on Taxable Expenditures

53.4945-1 Taxes on taxable expenditures.
53.4945-2 Propaganda influencing legislation.
53.4945-3 Influencing elections and carrying on voter registration 
          drives.
53.4945-4 Grants to individuals.
53.4945-5 Grants to organizations.
53.4945-6 Expenditures for noncharitable purposes.

                 Subpart G_Definitions and Special Rules

53.4946-1 Definitions and special rules.

            Subpart H_Application to Certain Nonexempt Trusts

53.4947-1 Application of tax.
53.4947-2 Special rules.

Subpart I_Tax on Investment Income of and Denial of Exemption to Certain 
                          Foreign Organizations

53.4948-1 Application of taxes and denial of exemption with respect to 
          certain foreign organizations.

             Subpart J_Black Lung Benefit Trust Excise Taxes

53.4951-1 Black lung trusts--taxes on self-dealing.
53.4952-1 Black lung trusts--taxes on taxable expenditures.

                   Subpart K_Second Tier Excise Taxes

53.4955-1 Tax on political expenditures.
53.4958-0 Table of contents.
53.4958-1 Taxes on excess benefit transactions.
53.4958-2 Definition of applicable tax-exempt organization.
53.4958-3 Definition of disqualified person.
53.4958-4 Excess benefit transaction.
53.4958-5 Transaction in which the amount of the economic benefit is 
          determined in whole or in part by the revenues of one or more 
          activities of the organization. [Reserved]
53.4958-6 Rebuttable presumption that a transaction is not an excess 
          benefit transaction.
53.4958-7 Correction.
53.4958-8 Special rules.
53.4961-1 Abatement of second tier taxes for correction within 
          correction period.
53.4961-2 Court proceedings to determine liability for second tier tax.
53.4963-1 Definitions.
53.4965-1 Overview.
53.4965-2 Covered tax-exempt entities.
53.4965-3 Prohibited tax shelter transactions.
53.4965-4 Definition of tax-exempt party to a prohibited tax shelter 
          transaction.
53.4965-5 Entity managers and related definitions.
53.4965-6 Meaning of ``knows or has reason to know''.
53.4965-7 Taxes on prohibited tax shelter transactions.
53.4965-8 Definition of net income and proceeds and standard for 
          allocating net income or proceeds to various periods.
53.4965-9 Effective/applicability dates.

                 Subpart L_Procedure and Administration

53.6001-1 Notice or regulations requiring records, statements, and 
          special returns.
53.6011-1 General requirement of return, statement or list.

[[Page 43]]

53.6011-4 Requirement of statement disclosing participation in certain 
          transactions by taxpayers.
53.6060-1 Reporting requirements for tax return preparers.
53.6061-1 Signing of returns and other documents.
53.6065-1 Verification of returns.
53.6071-1 Time for filing returns.
53.6071-1T Time for filing returns (temporary).
53.6081-1 Automatic extension of time for filing the return to report 
          taxes due under section 4951 for self-dealing with a nuclear 
          decommissioning fund.
53.6091-1 Place for filing chapter 42 tax returns.
53.6091-2 Exceptional cases.
53.6107-1 Tax return preparer must furnish copy of return or claim for 
          refund to taxpayer and must retain a copy or record.
53.6109-1 Tax return preparers furnishing identifying numbers for 
          returns or claims for refund filed.
53.6151-1 Time and place for paying tax shown on returns.
53.6161-1 Extension of time for paying tax or deficiency.
53.6165-1 Bonds where time to pay tax or deficiency has been extended.
53.6601-1 Interest on underpayment, nonpayment, or extensions of time 
          for payment, of tax.
53.6651-1 Failure to file tax return or to pay tax.
53.6694-1 Section 6694 penalties applicable to tax return preparer.
53.6694-2 Penalties for understatement due to an unreasonable position.
53.6694-3 Penalty for understatement due to willful, reckless, or 
          intentional conduct.
53.6694-4 Extension of period of collection when tax return preparer 
          pays 15 percent of a penalty for understatement of taxpayer's 
          liability and certain other procedural matters.
53.6695-1 Other assessable penalties with respect to the preparation of 
          tax returns or claims for refund for other persons.
53.6696-1 Claims for credit or refund by tax return preparers.
53.7101-1 Form of bonds.
53.7701-1 Tax return preparer.

    Authority: 26 U.S.C. 7805.
    Section 53.6060-1 also issued under 26 U.S.C. 6060(a);
    Section 53.6081-1 also issued under 26 U.S.C. 6081(a);
    Section 53.6109-1 also issued under 26 U.S.C. 6109(a);
    Section 53.6109-2 also issued under 26 U.S.C. 6109(a);
    Section 53.6695-1 also issued under 26 U.S.C. 6695(b).



                  Subpart A_Taxes on Investment Income



Sec. 53.4940-1  Excise tax on net investment income.

    (a) In general. For taxable years beginning after September 30, 
1977, section 4940 imposes an excise tax of 2 percent of the net 
investment income (as defined in section 4940(c) and paragraph (c) of 
this section) of a tax-exempt private foundation (as defined in section 
509). For taxable years beginning after December 31, 1969, and before 
October 1, 1977, the tax imposed by section 4940 is 4 percent of the net 
investment income. This tax will be reported on the form the foundation 
is required to file under section 6033 for the taxable year and will be 
paid annually at the time prescribed for filing such annual return 
(determined without regard to any extension of time for filing). In 
addition, an excise tax is imposed in the manner prescribed in paragraph 
(b) of this section on certain non-exempt private foundations (including 
certain non-exempt charitable trusts). Except as provided in the 
succeeding sentence, this tax is to be reported by means of a schedule 
attached to the organization's income tax return. For taxable years 
ending on or after December 31, 1975, the tax imposed by section 4940(b) 
and paragraph (b) of this section on a trust described in section 
4947(a)(1) which is a private foundation shall be reported on Form 5227. 
The tax imposed by section 4940(b) and this section is to be paid 
annually at the time the organization is required to pay its income 
taxes imposed under subtitle A. Except as otherwise provided herein, no 
exclusions or deductions from gross investment income or credits against 
tax are allowable under this section.
    (b) Taxable foundations. (1) The excise tax imposed under section 
4940 on private foundations which are not exempt from taxation under 
section 501(a) is equal to:
    (i) The amount (if any) by which the sum of
    (A) The tax on net investment income imposed under section 4940(a), 
computed as if such private foundation were exempt from taxation under 
section 501(a) and described in section 501(c)(3) for the taxable year, 
plus

[[Page 44]]

    (B) The amount of the tax which would have been imposed under 
section 511 for such taxable year if such private foundation had been 
exempt from taxation under section 501(a), exceeds.
    (ii) The tax imposed under subtitle A on such private foundation for 
the taxable year.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. Assume that the tax liability under subtitle A for 
private foundation X, which is not exempt from taxation under section 
501(a) for 1970, is $10,000. Had X been exempt under section 501(a) for 
1970, the tax imposed under section 4940(a) would have been $4,000 and 
the tax imposed under section 511 would have been $7,000. The excess of 
the sum of the taxes which would have been imposed under sections 
4940(a) and 511 ($11,000) over the tax that was imposed under subtitle A 
($10,000) is $1,000, the amount of the tax imposed on such organization 
under section 4940(b).
    Example 2. Assume the facts stated in Example (1), except that the 
tax liability under subtitle A is $15,000 rather than $10,000. Because 
the sum of the taxes which would have been imposed under sections 
4940(a) and 511 ($11,000) does not exceed the tax that was imposed under 
subtitle A ($15,000), there is no tax imposed under section 4940(b) with 
respect to such foundation.

    (c) Net investment income defined--(1) In general. For purposes of 
section 4940(a), net investment income of a private foundation is the 
amount by which:
    (i) The sum of the gross investment income (as defined in section 
4940(c)(2) and paragraph (d) of this section) and the capital gain net 
income (net capital gain for taxable years beginning before January 1, 
1977) (within the meaning of section 4940(c)(4) and paragraph (f) of 
this section) exceeds
    (ii) The deductions allowed by section 4940(c)(3) and paragraph (e) 
of this section.

Except to the extent inconsistent with the provisions of this section, 
net investment income shall be determined under the principles of 
Subtitle A.
    (2) Tax-exempt income. For purposes of computing net investment 
income under section 4940, the provisions of section 103 (relating to 
interest on certain governmental obligations) and section 265 (relating 
to expenses and interest relating to tax-exempt income) and the 
regulations thereunder shall apply.
    (d) Gross investment income--(1) In general. For purposes of 
paragraph (c) of this section, ``gross investment income'' means the 
gross amounts of income from interest, dividends, rents, and royalties 
(including overriding royalties) received by a private foundation from 
all sources, but does not include such income to the extent included in 
computing the tax imposed by section 511. Under this definition, 
interest, dividends, rents, and royalties derived from assets devoted to 
charitable activities are includible in gross investment income. 
Therefore, for example, interest received on a student loan would be 
includible in the gross investment income of a private foundation making 
such loan. For purposes of paragraph (c) of this section, gross 
investment income also includes the items of investment income described 
in Sec. 1.512(b)-1(a).
    (2) Certain estate and trust disbursements. In the case of a 
distribution from an estate or a trust described in section 4947(a) (1) 
or (2), such distribution shall not retain its character in the hands of 
the distributee for purposes of computing the tax under section 4940; 
except that, in the case of a distribution from a trust described in 
section 4947(a)(2), the income of such trust attributable to transfers 
in trust after May 26, 1969, shall retain its character in the hands of 
a distributee private foundation for purposes of section 4940 (unless 
such income is taken into account because of the application of section 
671).
    (3) Treatment of certain distributions in redemption of stock. For 
purposes of applying section 302(b)(1), any distribution made to a 
private foundation by a disqualified person (as defined in section 
4946(a)), in redemption of stock held by such private foundation in a 
business enterprise shall be treated as not essentially equivalent to a 
dividend if all of the following conditions are satisfied: (i) Such 
redemption is of stock which was owned by a private foundation on May 
26, 1969 (or which is acquired by a private foundation under the terms 
of a trust which was irrevocable on May 26, 1969, or under the terms of 
a will executed on or before

[[Page 45]]

such date, which is in effect on such date and at all times thereafter, 
or would have passed under such a will but before that time actually 
passes under a trust which would have met the test of this subdivision 
but for the fact that the trust was revocable (but was not in fact 
revoked)); (ii) such foundation is required to dispose of such property 
in order not to be liable for tax under section 4943 (relating to taxes 
on excess business holdings); and (iii) such foundation receives in 
return an amount which equals or exceeds the fair market value of such 
property at the time of such disposition or at the time a contract for 
such disposition was previously executed in a transaction which would 
not constitute a prohibited transaction (within the meaning of section 
503(b) or the corresponding provisions of prior law). In the case of a 
disposition before January 1, 1975, section 4943 shall be applied 
without taking section 4943(c) (4) into account. A distribution which 
otherwise qualifies under section 302 as a distribution in part or full 
payment in exchange for stock shall not be treated as essentially 
equivalent to a dividend because it does not meet the requirements of 
this subparagraph.
    (e) Deductions--(1) In general. (i) For purposes of computing net 
investment income, there shall be allowed as a deduction from gross 
investment income all the ordinary and necessary expenses paid or 
incurred for the production or collection of gross investment income or 
for the management, conservation, or maintenance of property held for 
the production of such income, determined with the modifications set 
forth in subparagraph (2) of this paragraph. Such expenses include that 
portion of a private foundation's operating expenses which is paid or 
incurred for the production or collection of gross investment income. 
Taxes paid or incurred under this section are not paid or incurred for 
the production or collection of gross investment income. A private 
foundation's operating expenses include compensation of officers, other 
salaries and wages of employees, outside professional fees, interest, 
and rent and taxes upon property used in the foundation's operations. 
Where a private foundation's officers or employees engage in activities 
on behalf of the foundation for both investment purposes and for exempt 
purposes, compensation and salaries paid to such officers or employees 
must be allocated between the investment activities and the exempt 
activities. To the extent a private foundation's expenses are taken into 
account in computing the tax imposed by section 511, they shall not be 
deductible for purposes of computing the tax imposed by section 4940.
    (ii) Where only a portion of property produces, or is held for the 
production of, income subject to the section 4940 excise tax, and the 
remainder of the property is used for exempt purposes, the deductions 
allowed by section 4940(c)(3) shall be apportioned between the exempt 
and non-exempt uses.
    (iii) No amount is allowable as a deduction under this section to 
the extent it is paid or incurred for purposes other than those 
described in subdivision (i) of this subparagraph. Thus, for example, 
the deductions prescribed by the following sections are not allowable: 
(1) The charitable deduction prescribed under section 170 and 642(c); 
(2) the net operating loss deduction prescribed under section 172; and 
(3) the special deductions prescribed under Part VIII, Subchapter B, 
Chapter 1.
    (2) Deduction modifications. The following modifications shall be 
made in determining deductions otherwise allowable under this paragraph:
    (i) The depreciation deduction shall be allowed, but only on the 
basis of the straight line method provided in section 167(b)(1).
    (ii) The depletion deduction shall be allowed, but such deduction 
shall be determined without regard to section 613, relating to 
percentage depletion.
    (iii) The basis to be used for purposes of the deduction allowed for 
depreciation or depletion shall be the basis determined under the rules 
of Part II of Subchapter O of Chapter 1, subject to the provisions of 
section 4940(c)(3)(B), and without regard to section 4940(c)(4)(B), 
relating to the basis for determining gain, or section 362(c). Thus, a 
private foundation must reduce the cost or other substituted or 
transferred basis by an amount equal to the straight line depreciation 
or cost depletion, without regard to whether the

[[Page 46]]

foundation deducted such depreciation or depletion during the period 
prior to its first taxable year beginning after December 31, 1969. 
However, where a private foundation has previously taken depreciation or 
depletion deductions in excess of the amount which would have been taken 
had the straight line or cost method been employed, such excess 
depreciation or depletion also shall be taken into account to reduce 
basis. If the facts necessary to determine the basis of property in the 
hands of the donor or the last preceding owner by whom it was not 
acquired by gift are unknown to a donee private foundation, then the 
original basis to such foundation of such property shall be determined 
under the rules of Sec. 1.1015-1(a)(3).
    (iv) The deduction for expenses paid or incurred in any taxable year 
for the production of gross investment income earned as an incident to a 
charitable function shall be no greater than the income earned from such 
function which is includible as gross investment income for such year. 
For example, where rental income is incidentally realized in 1971 from 
historic buildings held open to the public, deductions for amounts paid 
or incurred in 1971 for the production of such income shall be limited 
to the amount of rental income includible as gross investment income for 
1971.
    (f) Capital gain and losses--(1) General rule. In determining 
capital gain net income (net capital gain for taxable years beginning 
before January 1, 1977) for purposes of the tax imposed by section 4940, 
there shall be taken into account only capital gains and losses from the 
sale or other disposition of property held by a private foundation for 
investment purposes (other than program-related investments, as defined 
in section 4944(c)), and property used for the production of income 
included in computing the tax imposed by section 511 except to the 
extent gain or loss from the sale or other disposition of such property 
is taken into account for purposes of such tax. For taxable years 
beginning after December 31, 1972, property shall be treated as held for 
investment purposes even though such property is disposed of by the 
foundation immediately upon its receipt, if it is property of a type 
which generally produces interest, dividends, rents, royalties, or 
capital gains through appreciation (for example, rental real estate, 
stock, bonds, mineral interests, mortgages, and securities). Under this 
subparagraph, gains and losses from the sale or other disposition of 
property used for the exempt purposes of the private foundation are 
excluded. For example, gain or loss on the sale of the buildings used 
for the exempt activities of a private foundation would not be subject 
to the section 4940 tax. Where the foundation uses property for its 
exempt purposes, but also incidentally derives income from such property 
which is subject to the tax imposed by section 4940(a), any gain or loss 
resulting from the sale or other disposition of such property is not 
subject to the tax imposed by section 4940(a). For example, if a tax-
exempt private foundation maintains buildings of a historical nature and 
keeps them open for public inspection, but requires a number of its 
employees to live in these buildings and charges the employees rent, the 
rent would be subject to the tax imposed by section 4940(a), but any 
gain or loss resulting from the sale of such property would not be 
subject to such tax. However, where the foundation uses property for 
both exempt purposes and (other than incidentally) for investment 
purposes (for example, a building in which the foundation's charitable 
and investment activities are carried on), that portion of any gain or 
loss from the sale or other disposition of such property which is 
allocable to the investment use of such property must be taken into 
account in computing capital gain net income (net capital gain for 
taxable years beginning before January 1, 1977) for such taxable year. 
For purposes of this paragraph, a distribution of property for purposes 
described in section 170(c) (1) or (2)(B) which is a qualifying 
distribution under section 4942 shall not be treated as a sale or other 
disposition of property.
    (2) Basis. (i) The basis for purposes of determining gain from the 
sale or other disposition of property shall be the greater of:
    (A) Fair market value on December 31, 1969, plus or minus all 
adjustments

[[Page 47]]

after December 31, 1969, and before the date of disposition under the 
rules of Part II of Subchapter O of Chapter 1, provided that the 
property was held by the private foundation on December 31, 1969, and 
continuously thereafter to the date of disposition, or
    (B) Basis as determined under the rules of Part II of Subchapter O 
of Chapter 1,

subject to the provisions of section 4940(c)(3)(B) (and without regard 
to section 362(c)).
    (ii) For purposes of determining loss from the sale or other 
disposition of property, basis as determined in subdivision (i)(B) of 
this subparagraph shall apply.
    (3) Losses. Where the sale or other disposition of property referred 
to in section 4940(c)(4)(A) results in a capital loss, such loss may be 
subtracted from capital gains from the sale or other disposition of 
other such property during the same taxable year, but only to the extent 
of such gains. Should losses from the sale or other disposition of such 
property exceed gains from the sale or other disposition of such 
property during the same taxable year, such excess may not be deducted 
from gross investment income under section 4940(c)(3) in any taxable 
year, nor may such excess by used to reduce gains in either prior or 
future taxable years, regardless of whether the foundation is a 
corporation or a trust.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A private foundation holds certain depreciable real 
property on December 31, 1969, having a basis of $102,000. The fair 
market value of such property on that date was $100,000. For its taxable 
year 1970 the foundation was allowed depreciation for such property of 
$5,100 on the straight line method, the allowable amount computed on the 
$102,000 basis. The property was sold on January 1, 1971, for $100,000. 
Because fair market value on December 31, 1969, less straight line 
depreciation of $5,100 ($94,900) is less than basis as determined by 
Part II of Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), a 
gain of $3,100 is recognized (i.e., sales price of $100,000 less the 
greater of the two possible bases).
    Example 2. Assume the same facts in example 1, except that the sale 
price was $95,000. Because the sale price was $1,900 less than the basis 
for loss ($96,900 as determined by the application of subparagraph 
(2)(ii) of this paragraph), there is a capital loss of $1,900 which may 
be deducted against capital gains for 1971 (if any) in determining net 
capital gain (capital gain net income for taxable years beginning after 
December 31, 1976).
    Example 3. A private foundation holds certain depreciable real 
property on December 31, 1969, having a basis of $102,000. The fair 
market value of such property on that date was $110,000. For its taxable 
year 1970 the foundation was allowed depreciation for such property of 
$5,100 on the straight line method, the allowable amount computed on the 
$102,000 basis. The property was sold on January 1, 1971, for $100,000. 
Fair market value on December 31, 1969, less straight line depreciation 
of $5,100 ($104,900) exceeds basis as determined by Part II of 
Subchapter O of Chapter 1, $96,900 ($102,000 less $5,100), and will be 
used for purposes of determining gain. Because basis for purposes of 
determining gain exceeds sale price, there is no gain. There is no loss 
because basis for purposes of determining loss ($96,900) is less than 
sale price.

[T.D. 7250, 38 FR 868, Jan. 5, 1973; 38 FR 7549, Mar. 23, 1973, as 
amended by T.D. 7407, 41 FR 9321, Mar. 4, 1976; T.D. 7606, 44 FR 18971, 
Mar. 30, 1979; T.D. 7728, 45 FR 72651, Nov. 3, 1980; T.D. 8423, 57 FR 
33444, July 29, 1992]



                     Subpart B_Taxes on Self-Dealing

    Source: T.D. 7270, 38 FR 9493, Apr. 17, 1973, unless otherwise 
noted.



Sec. 53.4941(a)-1  Imposition of initial taxes.

    (a) Tax on self-dealer--(1) In general. Section 4941(a)(1) of the 
code imposes an excise tax on each act of self-dealing between a 
disqualified person (as defined in section 4946(a)) and a private 
foundation. Except as provided in subparagraph (2) of this paragraph, 
this tax shall be imposed on a disqualified person even though he had no 
knowledge at the time of the act that such act constituted self-dealing. 
Notwithstanding the preceding two sentences, however, a transaction 
between a disqualified person and a private foundation will not 
constitute an act of self-dealing if:
    (i) The transaction is a purchase or sale of securities by a private 
foundation through a stockbroker where normal trading procedures on a 
stock exchange or recognized over-the-counter market are followed;
    (ii) Neither the buyer nor the seller of the securities nor the 
agent of either

[[Page 48]]

knows the identity of the other party involved; and
    (iii) The sale is made in the ordinary course of business, and does 
not involve a block of securities larger than the average daily trading 
volume of that stock over the previous 4 weeks.

However, the preceding sentence shall not apply to a transaction 
involving a dealer who is a disqualified person acting as a principal or 
to a transaction which is an act of self-dealing pursuant to section 
4941(d)(1)(B) and Sec. 53.4941(d)-2 (c)(1). The tax imposed by section 
4941(a)(1) is at the rate of 5 percent of the amount involved (as 
defined in section 4941(e)(2) and Sec. 53.4941(e)-1(b)) with respect to 
the act of self-dealing for each year or partial year in the taxable 
period (as defined in section 4941(e)(1)) and shall be paid by any 
disqualified person (other than a foundation manager acting only in the 
capacity of a foundation manager) who participates in the act of self-
dealing. However, if a foundation manager is also acting as a self-
dealer, he may be liable for both the tax imposed by section 4941(a)(1) 
and the tax imposed by section 4941(a)(2).
    (2) Government officials. In the case of a government official (as 
defined in sec. 4946(a)), the tax shall be imposed upon such government 
official who participates in an act of self-dealing, only if he knows 
that such act is an act of self-dealing. See paragraph (b)(3) of this 
section for a definition of knowing.
    (3) Participation. For purposes of this paragraph, a disqualified 
person shall be treated as participating in an act of self-dealing in 
any case in which he engages or takes part in the transaction by himself 
or with others, or directs any person to do so.
    (b) Tax on foundation manager--(1) In general. Section 4941(a)(2) of 
the code imposes an excise tax on the participation of any foundation 
manager in an act of self-dealing between a disqualified person and a 
private foundation. This tax is imposed only in cases in which the 
following circumstances are present:
    (i) A tax is imposed by section 4941(a)(1),
    (ii) Such participating foundation manager knows that the act is an 
act of self-dealing, and
    (iii) The participation by the foundation manager is willful and is 
not due to reasonable cause.

The tax imposed by section 4941(a)(2) is at the rate of 2\1/2\ percent 
of the amount involved with respect to the act of self-dealing for each 
year or partial year in the taxable period and shall be paid by any 
foundation manager described in subdivisions (ii) and (iii) of this 
subparagraph.
    (2) Participation. The term ``participation'' shall include silence 
or inaction on the part of a foundation manager where he is under a duty 
to speak or act, as well as any affirmative action by such manager. 
However, a foundation manager will not be considered to have 
participated in an act of self-dealing where he has opposed such act in 
a manner consistent with the fulfillment of his responsibilities to the 
private foundation.
    (3) Knowing. For purposes of section 4941, a person shall be 
considered to have participated in a transaction ``knowing'' that it is 
an act of self-dealing only if:
    (i) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such transaction would be an act of self-
dealing,
    (ii) He is aware that such an act under these circumstances may 
violate the provisions of Federal tax law governing self-dealing, and
    (iii) He negligently fails to make reasonable attempts to ascertain 
whether the transaction is an act of self-dealing, or he is in fact 
aware that it is such an act.

For purposes of this part and Chapter 42, the term ``knowing'' does not 
mean ``having reason to know''. However, evidence tending to show that a 
person has reason to know of a particular fact or particular rule is 
relevant in determining whether he had actual knowledge of such fact or 
rule. Thus, for example, evidence tending to show that a person has 
reason to know of sufficient facts so that, based solely upon such 
facts, a transaction would be an act of self-dealing is relevant in 
determining whether he has actual knowledge of such facts.
    (4) Willful. Participation by a foundation manager shall be deemed 
willful if

[[Page 49]]

it is voluntary, conscious, and intentional. No motive to avoid the 
restrictions of the law or the incurrence of any tax is necessary to 
make the participation willful. However, participation by a foundation 
manager is not willful if he does not know that the transaction in which 
he is participating is an act of self-dealing.
    (5) Due to reasonable cause. A foundation manager's participation is 
due to reasonable cause if he has exercised his responsibility on behalf 
of the foundation with ordinary business care and prudence.
    (6) Advice of counsel. If a person, after full disclosure of the 
factual situation to legal counsel (including house counsel), relies on 
the advice of such counsel expressed in a reasoned written legal opinion 
that an act is not an act of self-dealing under section 4941, although 
such act is subsequently held to be an act of self-dealing, the person's 
participation in such act will ordinarily not be considered ``knowing'' 
or ``willful'' and will ordinarily be considered ``due to reasonable 
cause'' within the meaning of section 4941(a)(2). For purposes of this 
subparagraph, a written legal opinion will be considered ``reasoned'' 
even if it reaches a conclusion which is subsequently determined to be 
incorrect so long as such opinion addresses itself to the facts and 
applicable law. However, a written legal opinion will not be considered 
``reasoned'' if it does nothing more than recite the facts and express a 
conclusion. However, the absence of advice of counsel with respect to an 
act shall not, by itself, give rise to any inference that a person 
participated in such act knowingly, willfully, or without reasonable 
cause.
    (c) Burden of proof. For provisions relating to the burden of proof 
in cases involving the issue whether a foundation manager or a 
government official has knowingly participated in an act of self-
dealing, see section 7454(b).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7299, 38 FR 
35304, Dec. 27, 1973]



Sec. 53.4941(b)-1  Imposition of additional taxes.

    (a) Tax on self-dealer. Section 4941(b)(1) of the Code imposes an 
excise tax in any case in which an initial tax is imposed by section 
4941(a)(1) on an act of self-dealing by a disqualified person with a 
private foundation and the act is not corrected within the taxable 
period (as defined in Sec. 53.4941(e)-1(a)). The tax imposed by section 
4941(b)(1) is at the rate of 200 percent of the amount involved and 
shall be paid by any disqualified person (other than a foundation 
manager action only in the capacity of a foundation manager) who 
participated in the act of self-dealing.
    (b) Tax on foundation manager. Section 4941(b)(2) of the Code 
imposes an excise tax to be paid by a foundation manager in any case in 
which a tax is imposed by section 4941(b)(1) and the foundation manager 
refused to agree to part or all of the correction of the self-dealing 
act. The tax imposed by section 4941(b)(2) is at the rate of 50 percent 
of the amount involved and shall be paid by any foundation manager who 
refused to agree to part or all of the correction of the self-dealing 
act. For the limitations on liability of a foundation manager, see Sec. 
53.4941(c)-1(b).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR 
16301, May 2, 1986]



Sec. 53.4941(c)-1  Special rules.

    (a) Joint and several liability. (1) In any case where more than one 
person is liable for the tax imposed by any paragraph of section 4941 
(a) or (b), all such persons shall be jointly and severally liable for 
the taxes imposed under such paragraph with respect to such act of self-
dealing.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A and B, who are managers of private foundation X, lend one 
of the foundation's paintings to G, a disqualified person, for display 
in G's office, in a transaction which gives rise to liability for tax 
under section 4941(a)(2) (relating to tax on foundation managers). An 
initial tax is imposed on both A and B with respect to the act of 
lending the foundation's painting to G. A and B are jointly and 
severally liable for the tax.

    (b) Limits on liability for management. (1) The maximum aggregate 
amount of tax collectible under section 4941(a)(2) from all foundation 
managers with respect to any one act of self-dealing shall be $10,000, 
and the maximum aggregate amount of tax collectible

[[Page 50]]

under section 4941(b)(2) from all foundation managers with respect to 
any one act of self-dealing shall be $10,000.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A, a disqualified person with respect to private foundation 
Y, sells certain real estate having a fair market value of $500,000 to Y 
for $500,000 in cash. B, C, and D, all the managers of foundation Y, 
authorized the purchase on Y's behalf knowing that such purchase was an 
act of self-dealing. The actions of B, C, and D in approving the 
purchase were willful and not due to reasonable cause. Initial taxes are 
imposed upon the foundation managers under subsections (a)(2) and (c)(2) 
of section 4941. The tax to be paid by the foundation managers is 
$10,000 (the lesser of $10,000 or 2\1/2\ percent of the amount 
involved). The managers are jointly and severally liable for this 
$10,000, and this sum may be collected by the Internal Revenue Service 
from any one of them.



Sec. 53.4941(d)-1  Definition of self-dealing.

    (a) In general. For purposes of section 4941, the term self-dealing 
means any direct or indirect transaction described in Sec. 53.4941(d)-
2. For purposes of this section, it is immaterial whether the 
transaction results in a benefit or a detriment to the private 
foundation. The term ``self-dealing'' does not, however, include a 
transaction between a private foundation and a disqualified person where 
the disqualified person status arises only as a result of such 
transaction. For example, the bargain sale of property to a private 
foundation is not a direct act of self-dealing if the seller becomes a 
disqualified person only by reason of his becoming a substantial 
contributor as a result of the bargain element of the sale. For the 
effect of sections 4942, 4943, 4944, and 4945 upon an act of self-
dealing which also results in the imposition of tax under one or more of 
such sections, see the regulations under those sections.
    (b) Indirect self-dealing--(1) Certain business transactions. The 
term ``indirect self-dealing'' shall not include any transaction 
described in Sec. 53.4941(d)-2 between a disqualified person and an 
organization controlled by a private foundation (within the meaning of 
paragraph (6)(5) of this section) if:
    (i) The transaction results from a business relationship which was 
established before such transaction constituted an act of self-dealing 
(without regard to this paragraph),
    (ii) The transaction was at least as favorable to the organization 
controlled by the foundation as an arm's-length transaction with an 
unrelated person, and
    (iii) Either:
    (a) The organization controlled by the foundation could have engaged 
in the transaction with someone other than a disqualified person only at 
a severe economic hardship to such organization, or
    (b) Because of the unique nature of the product or services provided 
by the organization controlled by the foundation, the disqualified 
person could not have engaged in the transaction with anyone else, or 
could have done so only by incurring severe economic hardship. See 
example (2) of subparagraph (8) of this paragraph.
    (2) Grants to intermediaries. The term ``indirect self-dealing'' 
shall not include a transaction engaged in with a government official by 
an intermediary organization which is a recipient of a grant from a 
private foundation and which is not controlled by such foundation 
(within the meaning of paragraph (6) (5) of this section) if the private 
foundation does not earmark the use of the grant for any named 
government official and there does not exist an agreement, oral or 
written, whereby the grantor foundation may cause the selection of the 
government official by the intermediary organization. A grant by a 
private foundation is earmarked if such grant is made pursuant to an 
agreement, either oral or written, that the grant will be used by any 
named individual. Thus, a grant by a private foundation shall not 
constitute an indirect act of self-dealing even though such foundation 
had reason to believe that certain government officials would derive 
benefits from such grant so long as the intermediary organization 
exercises control, in fact, over the selection process and actually 
makes the selection completely independently of the private foundation. 
See example (3) of subparagraph (8) of this paragraph.
    (3) Transactions during the administration of an estate or revocable 
trust. The

[[Page 51]]

term ``indirect self-dealing'' shall not include a transaction with 
respect to a private foundation's interest or expectancy in property 
(whether or not encumbered) held by an estate (or revocable trust, 
including a trust which has become irrevocable on a grantor's death), 
regardless of when title to the property vests under local law, if:
    (i) The administrator or executor of an estate or trustee of a 
revocable trust either:
    (a) Possesses a power of sale with respect to the property,
    (b) Has the power to reallocate the property to another beneficiary, 
or
    (c) Is required to sell the property under the terms of any option 
subject to which the property was acquired by the estate (or revocable 
trust);
    (ii) Such transaction is approved by the probate court having 
jurisdiction over the estate (or by another court having jurisdiction 
over the estate (or trust) or over the private foundation);
    (iii) Such transaction occurs before the estate is considered 
terminated for Federal income tax purposes pursuant to paragraph (a) of 
Sec. 1.641(b)-3 of this chapter (or in the case of a revocable trust, 
before it is considered subject to sec. 4947);
    (iv) The estate (or trust) receives an amount which equals or 
exceeds the fair market value of the foundation's interest or expectancy 
in such property at the time of the transaction, taking into account the 
terms of any option subject to which the property was acquired by the 
estate (or trust); and
    (v) With respect to transactions occurring after April 16, 1973, the 
transaction either:
    (a) Results in the foundation receiving an interest or expectancy at 
least as liquid as the one it gave up,
    (b) Results in the foundation receiving an asset related to the 
active carrying out of its exempt purposes, or
    (c) Is required under the terms of any option which is binding on 
the estate (or trust).
    (4) Transactions with certain organizations. A transaction between a 
private foundation and an organization which is not controlled by the 
foundation (within the meaning of subparagraph (5) of this paragraph), 
and which is not described in section 4946(a)(1) (E), (F), or (G) 
because persons described in section 4946(a)(1) (A), (B), (C), or (D) 
own no more than 35 percent of the total combined voting power or 
profits or beneficial interest of such organization, shall not be 
treated as an indirect act of self-dealing between the foundation and 
such disqualified persons solely because of the ownership interest of 
such persons in such organization.
    (5) Control. For purposes of this paragraph, an organization is 
controlled by a private foundation if the foundation or one or more of 
its foundation managers (acting only in such capacity) may, only by 
aggregating their votes or positions of authority, require the 
organization to engage in a transaction which if engaged in with the 
private foundation would constitute self-dealing. Similarly, for 
purposes of this paragraph, an organization is controlled by a private 
foundation in the case of such a transaction between the organization 
and a disqualified person, if such disqualified person, together with 
one or more persons who are disqualified persons by reason of such a 
person's relationship (within the meaning of section 4946(a)(1) (C) 
through (G)) to such disqualified person, may, only by aggregating their 
votes or positions of authority with that of the foundation, require the 
organization to engage in such a transaction. The ``controlled'' 
organization need not be a private foundation; for example, it may be 
any type of exempt or nonexempt organization including a school, 
hospital, operating foundation, or social welfare organization. For 
purposes of this paragraph, an organization will be considered to be 
controlled by a private foundation or by a private foundation and 
disqualified persons referred to in the second sentence of this 
subparagraph if such persons are able, in fact, to control the 
organization (even if their aggregate voting power is less than 50 
percent of the total voting power of the organization's governing body) 
or if one or more of such persons has the right to exercise veto power 
over the actions of such organization relevant to any potential acts of 
self-dealing. A private foundation shall not be regarded as having 
control over an organization merely because it exercises expenditure 
responsibility (as defined

[[Page 52]]

in section 4945 (d)(4) and (h)) with respect to contributions to such 
organization. See example (6) of subparagraph (8) of this paragraph.
    (6) Certain transactions involving limited amounts. The term 
``indirect self-dealing'' shall not include any transaction between a 
disqualified person and an organization controlled by a private 
foundation (within the meaning of subparagraph (5) of this paragraph) or 
between two disqualified persons where the foundation's assets may be 
affected by the transaction if:
    (i) The transaction arises in the normal and customary course of a 
retail business engaged in with the general public,
    (ii) In the case of a transaction between a disqualified person and 
an organization controlled by a private foundation, the transaction is 
at least as favorable to the organization controlled by the foundation 
as an arm's-length transaction with an unrelated person, and
    (iii) The total of the amounts involved in such transactions with 
respect to any one such disqualified person in any one taxable year does 
not exceed $5,000.

See example (7) of subparagraph (8) of this paragraph.
    (7) Applicability of statutory exceptions to indirect self-dealing. 
The term ``indirect self-dealing'' shall not include a transaction 
involving one or more disqualified persons to which a private foundation 
is not a party, in any case in which the private foundation, by reason 
of section 4941(d)(2), could itself engage in such a transaction. Thus, 
for example, even if a private foundation has control (within the 
meaning of subparagraph (5) of this paragraph) of a corporation, the 
corporation may pay to a disqualified person, except a government 
official, reasonable compensation for personal services.
    (8) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Private foundation P owns the controlling interest of the 
voting stock of corporation X, and as a result of such interest, elects 
a majority of the board of directors of X. Two of the foundation 
managers, A and B, who are also directors of corporation X, form 
corporation Y for the purpose of building and managing a country club. A 
and B receive a total of 40 percent of Y's stock, making Y a 
disqualified person with respect to P under section 4946(a)(1)(E). In 
order to finance the construction and operation of the country club, Y 
requested and received a loan in the amount of $4 million from X. The 
making of the loan by X to Y shall constitute an indirect act of self-
dealing between P and Y.
    Example 2. Private foundation W owns the controlling interest of the 
voting stock of corporation X, a manufacturer of certain electronic 
computers. Corporation Y, a disqualified person with respect to W, owns 
the patent for, and manufactures, one of the essential component parts 
used in the computers. X has been making regular purchases of the 
patented component from Y since 1965, subject to the same terms as all 
other purchasers of such component parts. X could not buy similar 
components from another source. Consequently, X would suffer severe 
economic hardship if it could not continue to purchase these components 
from Y, since it would then be forced to develop a computer which could 
be constructed with other components. Under these circumstances, the 
continued purchase by X from Y of these components shall not be an 
indirect act of self-dealing between W and Y.
    Example 3. Private foundation Y made a grant to M University, an 
organization described in section 170(b)(1)(A)(ii), for the purpose of 
conducting a seminar to study methods for improving the administration 
of the judicial system. M is not controlled by Y within the meaning of 
subparagraph (5) of this paragraph. In conducting the seminar, M made 
payments to certain government officials. By the nature of the grant, Y 
had reason to believe that government officials would be compensated for 
participation in the seminar. M, however, had completely independent 
control over the selection of such participants. Thus, such grant by Y 
shall not constitute an indirect act of self-dealing with respect to the 
government officials.
    Example 4. A, a substantial contributor to P, a private foundation, 
bequeathed one-half of his estate to his spouse and one-half of his 
estate to P. Included in A's estate is a one-third interest in AB, a 
partnership. The other two-thirds interest in AB is owned by B, a 
disqualified person with respect to P. The one-third interest in AB was 
subject to an option agreement when it was acquired by the estate. The 
executor of A's estate sells the one-third interest in AB to B pursuant 
to such option agreement at the price fixed in such option agreement in 
a sale which meets the requirements of subparagraph (3) of this 
paragraph. Under these circumstances, the sale does not constitute an 
indirect act of self-dealing between B and P.

[[Page 53]]

    Example 5. A bequeathed $100,000 to his wife and a piece of 
unimproved real estate of equivalent value to private foundation Z, of 
which A was the creator and a foundation manager. Under the laws of 
State Y, to which the estate is subject, title to the real estate vests 
in the foundation upon A's death. However, the executor has the power 
under State law to reallocate the property to another beneficiary. 
During a reasonable period for administration of the estate, the 
executor exercises this power and distributes the $100,000 cash to the 
foundation and the real estate to A's wife. The probate court having 
jurisdiction over the estate approves the executor's action. Under these 
circumstances, the executor's action does not constitute an indirect act 
of self-dealing between the foundation and A's wife.
    Example 6. Private foundation P owns 20 percent of the voting stock 
of corporation W. A, a substantial contributor with respect to P, owns 
16 percent of the voting stock of corporation W. B, A's son, owns 15 
percent of the voting stock of corporation W. The terms of the voting 
stock are such that P, A, and B could vote their stock in a block to 
elect a majority of the board of directors of W. W is treated as 
controlled by P (within the meaning of subparagraph (5) of this 
paragraph) for purposes of this example A and B also own 50 percent of 
the stock of corporation Y, making Y a disqualified person with respect 
to P under section 4946(a)(1)(E). W makes a loan to Y of $1 million. The 
making of this loan by W to Y shall constitute an indirect act of self-
dealing between P and Y.
    Example 7. A, a disqualified person with respect to private 
foundation P, enters into a contract with corporation M, which is also a 
disqualified person with respect to P. P owns 20 percent of M's stock, 
and controls M within the meaning of subparagraph (5) of this paragraph. 
M is in the retail department store business. Purchases by A of goods 
sold by M in the normal and customary course of business at retail or 
higher prices are not indirect acts of self-dealing so long as the total 
of the amounts involved in all of such purchases by A in any one year 
does not exceed $5,000.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended at 38 FR 12604, May 
14, 1973]



Sec. 53.4941(d)-2  Specific acts of self-dealing.

    Except as provided in Sec. 53.4941(d)-3 or Sec. 53.4941(d)-4:
    (a) Sale or exchange of property--(1) In general. The sale or 
exchange of property between a private foundation and a disqualified 
person shall constitute an act of self-dealing. For example, the sale of 
incidental supplies by a disqualified person to a private foundation 
shall be an act of self-dealing regardless of the amount paid to the 
disqualified person for the incidental supplies. Similarly, the sale of 
stock or other securities by a disqualified person to a private 
foundation in a ``bargain sale'' shall be an act of self-dealing 
regardless of the amount paid for such stock or other securities. An 
installment sale may be subject to the provisions of both section 
4941(d)(1)(A) and section 4941(d)(1)(B).
    (2) Mortgaged property. For purposes of subparagraph (1) of this 
paragraph, the transfer of real or personal property by a disqualified 
person to a private foundation shall be treated as a sale or exchange if 
the foundation assumes a mortgage or similar lien which was placed on 
the property prior to the transfer, or takes subject to a mortgage or 
similar lien which a disqualified person placed on the property within 
the 10-year period ending on the date of transfer. For purposes of this 
subparagraph, the term ``similar lien'' shall include, but is not 
limited to, deeds of trust and vendors' liens, but shall not include any 
other lien if such lien is insignificant in relation to the fair market 
value of the property transferred.
    (b) Leases--(1) In general. Except as provided in subparagraphs (2) 
and (3) of this paragraph, the leasing of property between a 
disqualified person and a private foundation shall constitute an act of 
self-dealing.
    (2) Certain leases without charge. The leasing of property by a 
disqualified person to a private foundation shall not be an act of self-
dealing if the lease is without charge. For purposes of this 
subparagraph, a lease shall be considered to be without charge even 
though the private foundation pays for janitorial services, utilities, 
or other maintenance costs it incurs for the use of the property, so 
long as the payment is not made directly or indirectly to a disqualified 
person.
    (3) Certain leases of office space. For taxable years beginning 
after December 31, 1979, the leasing of office space by a disqualified 
person to a private foundation shall not be an act of self-dealing if:

[[Page 54]]

    (i) The leased space is in a building in which there are other 
tenants who are not disqualified persons,
    (ii) The lease is pursuant to a binding lease which was in effect on 
October 9, 1969, or pursuant to renewals of such a lease,
    (iii) The execution of the lease was not a prohibited transaction 
(within the meaning of section 503(b) or the corresponding provisions of 
prior law) at the time of such execution, and
    (iv) The terms of the lease (or any renewal) reflect an arm's length 
transaction.

A lease or renewal of such lease is described in this subparagraph (3) 
only if it satisfies the requirements of Sec. 53.4941(d)-4(c) (1) and 
(2), applied without regard to the December 31, 1979 deadline described 
therein.
    (c) Loans--(1) In general. Except as provided in subparagraphs (2), 
(3), and (4) of this paragraph, the lending of money or other extension 
of credit between a private foundation and a disqualified person shall 
constitute an act of self-dealing. Thus, for example, an act of self-
dealing occurs where a third party purchases property and assumes a 
mortgage, the mortgagee of which is a private foundation, and 
subsequently the third party transfers the property to a disqualified 
person who either assumes liability under the mortgage or takes the 
property subject to the mortgage. Similarly, except in the case of the 
receipt and holding of a note pursuant to a transaction described in 
Sec. 53.4941(d)-1(b)(3), an act of self-dealing occurs where a note, 
the obligor of which is a disqualified person, is transferred by a third 
party to a private foundation which becomes the creditor under the note.
    (2) Loans without interest. Subparagraph (1) of this paragraph shall 
not apply to the lending of money or other extension of credit by a 
disqualified person to a private foundation if the loan or other 
extension of credit is without interest or other charge.
    (3) Certain evidences of future gifts. The making of a promise, 
pledge, or similar arrangement to a private foundation by a disqualified 
person, whether evidenced by an oral or written agreement, a promissory 
note, or other instrument of indebtedness, to the extent motivated by 
charitable intent and unsupported by consideration, is not an extension 
of credit (within the meaning of this paragraph) before the date of 
maturity.
    (4) General banking functions. Under section 4941(d)(2)(E) the 
performance by a bank or trust company which is a disqualified person of 
trust functions and certain general banking services for a private 
foundation is not an act of self-dealing, where the banking services are 
reasonable and necessary to carrying out the exempt purposes of the 
private foundation, if the compensation paid to the bank or trust 
company, taking into account the fair interest rate for the use of the 
funds by the bank or trust company, for such services is not excessive. 
The general banking services allowed by this subparagraph are:
    (i) Checking accounts, as long as the bank does not charge interest 
on any overwithdrawals,
    (ii) Savings accounts, as long as the foundation may withdraw its 
funds on no more than 30-days notice without subjecting itself to a loss 
of interest on its money for the time during which the money was on 
deposit, and
    (iii) Safekeeping activities.

See example (3) Sec. 53.4941(d)-3(c)(2).
    (d) Furnishing goods, services, or facilities--(1) In general. 
Except as provided in subparagraph (2) or (3) of this paragraph (or 
Sec. 53.4941(d)-3(b)), the furnishing of goods, services, or facilities 
between a private foundation and a disqualified person shall constitute 
an act of self-dealing. This subparagraph shall apply, for example, to 
the furnishing of goods, services, or facilities such as office space, 
automobiles, auditoriums, secretarial help, meals, libraries, 
publications, laboratories, or parking lots. Thus, for example, if a 
foundation furnishes personal living quarters to a disqualified person 
(other than a foundation manager or employee) without charge, such 
furnishing shall be an act of self-dealing.
    (2) Furnishing of goods, services, or facilities to foundation 
managers and employees. The furnishing of goods, services, or facilities 
such as those described in subparagraph (1) of this paragraph to a 
foundation manager in

[[Page 55]]

recognition of his services as a foundation manager, or to another 
employee (including an individual who would be an employee but for the 
fact that he receives no compensation for his services) in recognition 
of his services in such capacity, is not an act of self-dealing if the 
value of such furnishing (whether or not includible as compensation in 
his gross income) is reasonable and necessary to the performance of his 
tasks in carrying out the exempt purposes of the foundation and, taken 
in conjunction with any other payment of compensation or payment or 
reimbursement of expenses to him by the foundation, is not excessive. 
For example, if a foundation furnishes meals and lodging which are 
reasonable and necessary (but not excessive) to a foundation manager by 
reason of his being a foundation manager, then, without regard to 
whether such meals and lodging are excludable from gross income under 
section 119 as furnished for the convenience of the employer, such 
furnishing is not an act of self-dealing. For the effect of section 
4945(d)(5) upon an expenditure for unreasonable administrative expenses, 
see Sec. 53.4945-6(b)(2).
    (3) Furnishing of goods, services, or facilities by a disqualified 
person without charge. The furnishing of goods, services, or facilities 
by a disqualified person to a private foundation shall not be an act of 
self-dealing if they are furnished without charge. Thus, for example, 
the furnishing of goods such as pencils, stationery, or other incidental 
supplies, or the furnishing of facilities such as a building, by a 
disqualified person to a foundation shall be allowed if such supplies or 
facilities are furnished without charge. Similarly, the furnishing of 
services (even though such services are not personal in nature) shall be 
permitted if such furnishing is without charge. For purposes of this 
subparagraph, a furnishing of goods shall be considered without charge 
even though the private foundation pays for transportation, insurance, 
or maintenance costs it incurs in obtaining or using the property, so 
long as the payment is not made directly or indirectly to the 
disqualified person.
    (e) Payment of compensation. The payment of compensation (or payment 
or reimbursement of expenses) by a private foundation to a disqualified 
person shall constitute an act of self-dealing. See, however, Sec. 
53.4941(d)-3(c) for the exception for the payment of compensation by a 
foundation to a disqualified person for personal services which are 
reasonable and necessary to carry out the exempt purposes of the 
foundation.
    (f) Transfer or use of the income or assets of a private 
foundation--(1) In general. 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. For purposes of the 
preceding sentence, the purchase or sale of stock or other securities by 
a private foundation shall be an act of self-dealing if such purchase or 
sale is made in an attempt to manipulate the price of the stock or other 
securities to the advantage of a disqualified person. Similarly, the 
indemnification (of a lender) or guarantee (of repayment) by a private 
foundation with respect to a loan to a disqualified person shall be 
treated as a use for the benefit of a disqualified person of the income 
or assets of the foundation (within the meaning of this subparagraph). 
In addition, if a private foundation makes a grant or other payment 
which satisfies the legal obligation of a disqualified person, such 
grant or payment shall ordinarily constitute an act of self-dealing to 
which this subparagraph applies. However, if a private foundation makes 
a grant or payment which satisfies a pledge, enforceable under local 
law, to an organization described in section 501(c)(3), which pledge is 
made on or before April 16, 1973, such grant or payment shall not 
constitute an act of self-dealing to which this subparagraph applies so 
long as the disqualified person obtains no substantial benefit, other 
than the satisfaction of his obligation, from such grant or payment.
    (2) Certain incidental benefits. The fact that a disqualified person 
receives an incidental or tenuous benefit from the use by a foundation 
of its income or assets will not, by itself, make such use an act of 
self-dealing. Thus, the public

[[Page 56]]

recognition a person may receive, arising from the charitable activities 
of a private foundation to which such person is a substantial 
contributor, does not in itself result in an act of self-dealing since 
generally the benefit is incidental and tenuous. 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. 
Similarly, a scholarship or a fellowship grant to a person other than a 
disqualified person, which is paid or incurred by a private foundation 
in accordance with a program which is consistent with:
    (i) The requirements of the foundation's exempt status under section 
501(c)(3),
    (ii) The requirements for the allowance of deductions under section 
170 for contributions made to the foundation, and
    (iii) The requirements of section 4945(g)(1),

will not be an act of self-dealing under section 4941(d)(1) merely 
because a disqualified person indirectly receives an incidental benefit 
from such grant. Thus, a scholarship or a fellowship grant made by a 
private foundation in accordance with a program to award scholarships or 
fellowship grants to the children of employees of a substantial 
contributor shall not constitute an act of self-dealing if the 
requirements of the preceding sentence are satisfied. For an example of 
the kind of scholarship program with an employment nexus that meets the 
above requirements, see Sec. 53.4945-4(b)(5) (example 1).
    (3) Non-compensatory indemnification of foundation managers against 
liability for defense in civil proceedings. (i) Except as provided in 
Sec. 53.4941(d)-3(c), section 4941(d)(1) shall not apply to the 
indemnification by a private foundation of a foundation manager, with 
respect to the manager's defense in any civil judicial or civil 
administrative proceeding arising out of the manager's performance of 
services (or failure to perform services) on behalf of the foundation, 
against all expenses (other than taxes, including taxes imposed by 
chapter 42, penalties, or expenses of correction) including attorneys' 
fees, judgments and settlement expenditures if--
    (A) Such expenses are reasonably incurred by the manager in 
connection with such proceeding; and
    (B) The manager has not acted willfully and without reasonable cause 
with respect to the act or failure to act which led to such proceeding 
or to liability for tax under chapter 42.
    (ii) Similarly, except as provided in Sec. 53.4941(d)-3(c), section 
4941(d)(1) shall not apply to premiums for insurance to make or to 
reimburse a foundation for an indemnification payment allowed pursuant 
to this paragraph (f)(3). Neither shall an indemnification or payment of 
insurance allowed pursuant to this paragraph (f)(3) be treated as part 
of the compensation paid to such manager for purposes of determining 
whether the compensation is reasonable under chapter 42.
    (4) Compensatory indemnification of foundation managers against 
liability for defense in civil proceedings. (i) The indemnification by a 
private foundation of a foundation manager for compensatory expenses 
shall be an act of self-dealing under this paragraph unless when such 
payment is added to other compensation paid to such manager the total 
compensation is reasonable under chapter 42. A compensatory expense for 
purposes of this paragraph (f) is--
    (A) Any penalty, tax (including a tax imposed by chapter 42), or 
expense of correction that is owed by the foundation manager;
    (B) Any expense not reasonably incurred by the manager in connection 
with a civil judicial or civil administrative proceeding arising out of 
the manager's performance of services on behalf of the foundation; or
    (C) Any expense resulting from an act or failure to act with respect 
to which the manager has acted willfully and without reasonable cause.
    (ii) Similarly, the payment by a private foundation of the premiums 
for an insurance policy providing liability insurance to a foundation 
manager for

[[Page 57]]

expenses described in this paragraph (f)(4) shall be an act of self-
dealing under this paragraph (f) unless when such premiums are added to 
other compensation paid to such manager the total compensation is 
reasonable under chapter 42.
    (5) Insurance allocation. A private foundation shall not be engaged 
in an act of self-dealing if the foundation purchases a single insurance 
policy to provide its managers both the noncompensatory and the 
compensatory coverage discussed in this paragraph (f), provided that the 
total insurance premium is allocated and that each manager's portion of 
the premium attributable to the compensatory coverage is included in 
that manager's compensation for purposes of determining reasonable 
compensation under chapter 42.
    (6) Indemnification. For purposes of this paragraph (f), the term 
indemnification shall include not only reimbursement by the foundation 
for expenses that the foundation manager has already incurred or 
anticipates incurring but also direct payment by the foundation of such 
expenses as the expenses arise.
    (7) Taxable income. The determination of whether any amount of 
indemnification or insurance premium discussed in this paragraph (f) is 
included in the manager's gross income for individual income tax 
purposes is made on the basis of the provisions of chapter 1 and without 
regard to the treatment of such amount for purposes of determining 
whether the manager's compensation is reasonable under chapter 42.
    (8) De minimis items. Any property or service that is excluded from 
income under section 132(a)(4) may be disregarded for purposes of 
determining whether the recipient's compensation is reasonable under 
chapter 42.
    (9) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation, makes a grant of $50,000 to the 
governing body of N City for the purpose of alleviating the slum 
conditions which exist in a particular neighborhood of N. Corporation P, 
a substantial contributor to M, is located in the same area in which the 
grant is to be used. Although the general improvement of the area may 
constitute an incidental and tenuous benefit to P, such benefit by 
itself will not constitute an act of self-dealing.
    Example 2. Private foundation X established a program to award 
scholarship grants to the children of employees of corporation M, a 
substantial contributor to X. After disclosure of the method of carrying 
out such program, X received a determination letter from the Internal 
Revenue Service stating that X is exempt from taxation under section 
501(c)(3), that contributions to X are deductible under section 170, and 
that X's scholarship program qualifies under section 4945(g)(1). A 
scholarship grant to a person not a disqualified person with respect to 
X paid or incurred by X in accordance with such program shall not be an 
indirect act of self-dealing between X and M.
    Example 3. Private foundation Y owns voting stock in corporation Z, 
the management of which includes certain disqualified persons with 
respect to Y. Prior to Z's annual stockholder meeting, the management 
solicits and receives the foundation's proxies. The transfer of such 
proxies in and of itself shall not be an act of self-dealing.
    Example 4. A, a disqualified person with respect to private 
foundation S, contributes certain real estate to S for the purpose of 
building a neighborhood recreation center in a particular 
underprivileged area. As a condition of the gift, S agrees to name the 
recreation center after A. Since the benefit to A is only incidental and 
tenuous, the naming of the recreation center, by itself, will not be an 
act of self-dealing.

    (g) Payment to a government official. Except as provided in section 
4941(d)(2)(G) or Sec. 53.4941(d)-3(e), the agreement by a private 
foundation to make any payment of money or other property to a 
government official, as defined in section 4946(c), shall constitute an 
act of self-dealing. For purposes of this paragraph, an individual who 
is otherwise described in section 4946(c) shall be treated as a 
government official while on leave of absence from the government 
without pay.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR 
3848, Jan. 31, 1984; T.D. 8639, 60 FR 65568, Dec. 20, 1995]



Sec. 53.4941(d)-3  Exceptions to self-dealing.

    (a) General rule. In general, a transaction described in section 
4941(d)(2) (B), (C), (D), (E), (F), (G), or (H) is not an act of self-
dealing. Section 4941(d)(2) (B), (C), and (H) provide limited exceptions 
to certain specific transactions, as described in paragraphs (b)(2), 
(b)(3),

[[Page 58]]

(c)(2), and (d)(3) of Sec. 53.4941(d)-2. Section 4941(d)(2) (D), (E), 
(F), and (G) and paragraphs (b) through (e) of this section described 
certain transactions which are not acts of self-dealing.
    (b) Furnishing of goods, services, or facilities to a disqualified 
person--(1) In general. Under section 4941(d)(2)(D), the furnishing of 
goods, services, or facilities by a private foundation to a disqualified 
person shall not be an act of self-dealing if such goods, services, or 
facilities are made available to the general public on at least as 
favorable a basis as they are made available to the disqualified person. 
This subparagraph shall not apply, however, in the case of goods, 
services, or facilities furnished later than May 16, 1973, unless such 
goods, services, or facilities are functionally related, within the 
meaning of section 4942(j)(5), to the exercise or performance by a 
private foundation of its charitable, educational, or other purpose or 
function constituting the basis for its exemption under section 
501(c)(3).
    (2) General public. For purposes of this paragraph, the term 
``general public'' shall include those persons who, because of the 
particular nature of the activities of the private foundation, would be 
reasonably expected to utilize such goods, services, or facilities. This 
paragraph shall not apply, however, unless there is a substantial number 
of persons other than disqualified persons who are actually utilizing 
such goods, services, or facilities. Thus, a private foundation which 
furnishes recreational or park facilities to the general public may 
furnish such facilities to a disqualified person provided they are 
furnished to him on a basis which is not more favorable than that on 
which they are furnished to the general public. Similarly, the sale of a 
book or magazine by a private foundation to disqualified persons shall 
not be an act of self-dealing if the publication of such book or 
magazine is functionally related to a charitable or educational activity 
of the foundation and the book or magazine is made available to the 
disqualified persons and the general public at the same price. In 
addition, if the terms of the sale require, for example, payment within 
60 days from the date of delivery of the book or magazine, such terms 
are consistent with normal commercial practices, and payment is made 
within the 60-day period, the transaction shall not be treated as a loan 
or other extension of credit under Sec. 53.4941(d)-2(c)(1).
    (c) Payment of compensation for certain personal services--(1) In 
general. Under section 4941(d)(2)(E), except in the case of a Government 
official (as defined in section 4946(c)), the payment of compensation 
(and the payment or reimbursement of expenses, including reasonable 
advances for expenses anticipated in the immediate future) by a private 
foundation to a disqualified person for the performance of personal 
services which are reasonable and necessary to carry out the exempt 
purpose of the private foundation shall not be an act of self-dealing if 
such compensation (or payment or reimbursement) is not excessive. For 
purposes of this subparagraph the term ``personal services'' includes 
the services of a broker serving as agent for the private foundation, 
but not the services of a dealer who buys from the private foundation as 
principal and resells to third parties. For the determination whether 
compensation is excessive, see Sec. 1.162-7 of this chapter (Income Tax 
Regulations). This paragraph applies without regard to whether the 
person who receives the compensation (or payment or reimbursement) is an 
individual. The portion of any payment which represents payment for 
property shall not be treated as payment of compensation (or payment or 
reimbursement of expenses) for the performance of personal services for 
purposes of this paragraph. For rules with respect to the performance of 
general banking services, see Sec. 53.4941(d)-2(c)(4). Further, the 
making of a cash advance to a foundation manager or employee for 
expenses on behalf of the foundation is not an act of self-dealing, so 
long as the amount of the advance is reasonable in relation to the 
duties and expense requirements of the foundation manager. Except where 
reasonably allowable pursuant to subdivision (iii) of this subparagraph, 
such advances shall not ordinarily exceed $500. For example, if a 
foundation makes an advance to a foundation manager to cover anticipated 
out-of-

[[Page 59]]

pocket current expenses for a reasonable period (such as a month) and 
the manager accounts to the foundation under a periodic reimbursement 
program for actual expenses incurred, the foundation will not be 
regarded as having engaged in an act of self-dealing:
    (i) When it makes the advance,
    (ii) When it replenishes the funds upon receipt of supporting 
vouchers from the foundation manager, or
    (iii) If it temporarily adds to the advance to cover extraordinary 
expenses anticipated to be incurred in fulfillment of a special 
assignment (such as long distance travel).
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a partnership, is a firm of 10 lawyers engaged in the 
practice of law. A and B, partners in M, serve as trustees to private 
foundation W and, therefore, are disqualified persons. In addition, A 
and B own more than 35 percent of the profits interest in M, thereby 
making M a disqualified person. M performs various legal services for W 
from time to time as such services are requested. The payment of 
compensation by W to M shall not constitute an act of self-dealing if 
the services performed are reasonable and necessary for the carrying out 
of W's exempt purposes and the amount paid by W for such services is not 
excessive.
    Example 2. C, a manager of private foundation X, owns an investment 
counseling business. Acting in his capacity as an investment counselor, 
C manages X's investment portfolio for which he receives an amount which 
is determined to be not excessive. The payment of such compensation to C 
shall not constitute an act of self-dealing.
    Example 3. M, a commercial bank, serves as a trustee for private 
foundation Y. In addition to M's duties as trustee, M maintains Y's 
checking and savings accounts and rents a safety deposit box to Y. The 
use of the funds by M and the payment of compensation by Y to M for such 
general banking services shall be treated as the payment of compensation 
for the performance of personal services which are reasonable and 
necessary to carry out the exempt purposes of Y if such compensation is 
not excessive.
    Example 4. D, a substantial contributor to private foundation Z, 
owns a factory which manufactures microscopes. D contracts with Z to 
manufacture 100 microscopes for Z. Any payment to D under the contract 
shall constitute an act of self-dealing, since such payment does not 
constitute the payment of compensation for the performance of personal 
services.

    (d) Certain transactions between a foundation and a corporation--(1) 
In general. Under section 4941(d)(2)(F), any transaction between a 
private foundation and a corporation which is a disqualified person will 
not be an act of self-dealing if such transaction is engaged in pursuant 
to a liquidation, merger, redemption, recapitalization, or other 
corporate adjustment, organization, or reorganization, so long as all 
the securities of the same class as that held (prior to such 
transaction) by the foundation are subject to the same terms and such 
terms provide for receipt by the foundation of no less than fair market 
value. For purposes of this paragraph, all of the securities are not 
``subject to the same terms unless, pursuant to such transaction,'' The 
corporation makes a bona fide offer on a uniform basis to the foundation 
and every other person who holds such securities. The fact that a 
private foundation receives property, such as debentures, while all 
other persons holding securities of the same class receive cash for 
their interests, will be evidence that such offer was not made on a 
uniform basis. This paragraph may apply even if no other person holds 
any securities of the class held by the foundation. In such event, 
however, the consideration received by holders of other classes of 
securities, or the interests retained by holders of such other classes, 
when considered in relation to the consideration received by the 
foundation, must indicate that the foundation received at least as 
favorable treatment in relation to its interests as the holders of any 
other class of securities. In addition, the foundation must receive no 
less than the fair market value of its interests.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Private foundation X owns 50 percent of the class A 
preferred stock of corporation M, which is a disqualified person with 
respect to X. The terms of such securities provide that the stock may be 
called for redemption at any time by M at 105 percent of the face amount 
of the stock. M exercises this right and calls all the class A preferred 
stock by paying 105 percent of the face amount in cash. At the time of 
the redemption of the class A preferred stock, it is determined that the 
fair market value of the

[[Page 60]]

preferred stock is equal to its face amount. In such case, the 
redemption by M of the preferred stock of X is not an act of self-
dealing.
    Example 2. Private foundation Y, which is on a calendar year basis, 
acquires 60 percent of the class A preferred stock of corporation N by 
will on January 10, 1970. N, which is also on a calendar year basis, is 
a disqualified person with respect to Y. In 1971, N offers to redeem all 
of the class A preferred stock for a consideration equal to 100 percent 
of the face amount of such stock by the issuance of debentures. The 
offer expires January 2, 1972. Both Y and all other holders of the class 
A preferred stock accept the offer and enter into the transaction on 
January 2, 1972, at which time it is determined that the fair market 
value of the debentures is no less than the fair market value of the 
preferred stock. The transaction on January 2, 1972, shall not be 
treated as an act of self-dealing for 1972. However, because under Sec. 
53.4941 (e)-1 (e)(1)(i) an act of self dealing occurs on the first day 
of each taxable year or portion of a taxable year that an extension of 
credit from a foundation to a disqualified person goes uncorrected, if 
such debentures are held by Y after December 31, 1972, except as 
provided in Sec. 53.4941(d)-4(c)(4), such extension of credit shall not 
be excepted from the definition of an act of self dealing by reason of 
the January 2, 1972, transaction. See Sec. 53.4941(d)-4(c)(4) for rules 
indicating that under certain circumstances such debentures could be 
held by Y until December 31, 1979.

    (e) Certain payments to government officials. Under section 
4941(d)(2)(G), in the case of a government official, in addition to the 
exceptions provided in section 4941(d)(2) (B), (C), and (D), section 
4941(d)(1) shall not apply to:
    (1) A prize or award which is not includible in gross income under 
section 74(b), if the government official receiving such prize or award 
is selected from the general public;
    (2) A scholarship or a fellowship grant which is excludable from 
gross income under section 117(a) and which is to be utilized for study 
at an educational institution described in section 151(e)(4);
    (3) Any annuity or other payment (forming part of a stock-bonus, 
pension, or profit sharing plan) by a trust which constitutes a 
qualified trust under section 401;
    (4) Any annuity or other payment under a plan which meets the 
requirements of section 404(a)(2);
    (5) Any contribution or gift (other than a contribution or gift of 
money) to, or services or facilities made available to, any government 
official, if the aggregate value of such contributions, gifts, services, 
and facilities does not exceed $25 during any calendar year;
    (6) Any payment made under 5 U.S.C. Chapter 41 (relating to 
government employees' training programs);
    (7) Any payment or reimbursement of traveling expenses (including 
amounts expended for meals and lodging, regardless of whether the 
government official is away from home within the meaning of section 
162(a)(2), and including reasonable advances for such expenses 
anticipated in the immediate future) for travel solely from one point in 
the United States to another in connection with one or more purposes 
described in section 170(c) (1) or (2)(B), but only if such payment or 
reimbursement does not exceed the actual cost of the transportation 
involved plus an amount for all other traveling expenses not in excess 
of 125 percent of the maximum amount payable under 5 U.S.C. 5702(a) for 
like travel by employees of the United States;
    (8) Any agreement to employ or make a grant to a government official 
for any period after the termination of his government service if such 
agreement is entered into within 90 days prior to such termination;
    (9) If a government official attends or participates in a conference 
sponsored by a private foundation, the allocable portion of the cost of 
such conference and other nonmonetary benefits (for example, benefits of 
a professional, intellectual, or psychological nature, or benefits 
resulting from the publication or the distribution to participants of a 
record of the conference), as well as the payment or reimbursement of 
expenses (including reasonable advances for expenses anticipated in 
connection with such a conference in the near future), received by such 
government official as a result of such attendance or participation 
shall not be subject to section 4941(d)(1), so long as the conference is 
in furtherance of the exempt purposes of the foundation; or
    (10) In the case of any government official who was on leave of 
absence without pay on December 31, 1969, pursuant to a commitment 
entered into on or before such date for the purpose of

[[Page 61]]

engaging in certain activities for which such individual was to be paid 
by one or more private foundations, any payment of compensation (or 
payment or reimbursement of expenses, including reasonable advances for 
expenses anticipated in the immediate future) by such private 
foundations to such individual for any continuous period after December 
31, 1969, and prior to January 1, 1971, during which such individual 
remains on leave of absence to engage in such activities. A commitment 
is considered entered into on or before December 31, 1969, if on or 
before such date, the amount and nature of the payments to be made and 
the name of the individual receiving such payments were entered on the 
records of the payor, or were otherwise adequately evidenced, or the 
notice of the payment to be received was communicated to the payee 
orally or in writing.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7938, 49 FR 
3848, Jan. 31, 1984]



Sec. 53.4941(d)-4  Transitional rules.

    (a) Certain transactions involving securities acquired by a 
foundation before May 27, 1969--(1) In general. Under section 
101(l)(2)(A) of the Tax Reform Act of 1969 (83 Stat. 533), any 
transaction between a private foundation and a corporation which is a 
disqualified person shall not be an act of self-dealing if such 
transaction is pursuant to the terms of securities of such corporation, 
if such terms were in existence at the time such securities were 
acquired by the foundation, and if such securities were acquired by the 
foundation before May 27, 1969.
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Private foundation X purchased preferred stock of 
corporation M, a disqualified person with respect to X, on March 15, 
1969. The terms of such securities on such date provided that the stock 
could be called by M at any time if M paid the outstanding shareholders 
cash equal to 105 percent of the face amount of the stock. If M 
exercises this right and calls the stock owned by X on February 15, 
1970, such call shall not constitute an act of self-dealing even if such 
price is not equivalent to fair market value on such date and even if 
not all of the securities of that class are called.

    (b) Disposition of certain business holdings--(1) In general. Under 
section 101(l)(2)(B) of the Tax Reform Act of 1969 (83 Stat. 533), the 
sale, exchange, or other disposition of property which is owned by a 
private foundation on May 26, 1969, to a disqualified person shall not 
be an act of self-dealing if the foundation is required to dispose of 
such property in order not to be liable for tax under section 4943 
(determined without regard to section 4943(c)(2)(C) and as if every 
disposition by the foundation were made to disqualified persons) and if 
such disposition satisfies the requirements of subparagraph (2) of this 
paragraph. For purposes of applying this paragraph in the case of a 
disposition completed before January 1, 1975, or after October 4, 1976, 
and before January 1, 1977, the amount of excess business holdings is 
determined under section 4943(c) without taking subsection (c)(4) into 
account.
    (2) Terms of the disposition. Subparagraph (1) of this paragraph 
shall not apply unless:
    (i) The private foundation receives an amount which equals or 
exceeds the fair market value of the business holdings at the time of 
disposition or at the time a contract for such disposition was 
previously executed; and
    (ii) At the time with respect to which subdivision (i) of this 
subparagraph is applied, the transaction would not have constituted a 
prohibited transaction within the meaning of section 503(b) or the 
corresponding provisions of prior law if such provisions had been 
applied at such time.
    (3) Property received under a trust or will. For purposes of this 
paragraph, property shall be considered as owned by a private foundation 
on May 26, 1969, if such property is acquired by such foundation under 
the terms of a will executed on or before such date, under the terms of 
a trust which was irrevocable on such date, or under the terms of a 
revocable trust executed on or before such date if the property would 
have passed under a will which would have met the requirements of this 
subparagraph but for the fact that a grantor dies without having revoked 
the trust. An amendment or republication of a will which was executed on 
or before May 26, 1969, does not prevent any

[[Page 62]]

interest in a business enterprise which was to pass under the terms of 
such will (which terms were in effect on May 26, 1969, and at all times 
thereafter) from being treated as owned by a private foundation on or 
before May 26, 1969, solely because:
    (i) There is a reduction in the interest in the business enterprise 
which the foundation was to receive under the terms of the will (for 
example, if the foundation is to receive the residuary estate and one 
class of stock is disposed of by the decedent during his lifetime or by 
a subsequent codicil),
    (ii) Such amendment or republication is necessary in order to comply 
with section 508(e) and the regulations thereunder,
    (iii) There is a change in the executor of the will, or
    (iv) There is any other change which does not otherwise change the 
rights of the foundation with respect to such interest in the business 
enterprise.

However, if under such amendment or republication there is an increase 
of the interest in the business enterprise which the foundation was to 
receive under the terms of the will in effect on May 26, 1969, such 
increase shall not be treated as owned by the private foundation on or 
before May 26, 1969, but under such circumstances the interest which 
would have been acquired before such increase shall be treated as owned 
by the private foundation on or before May 26, 1969.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. On May 26, 1969, private foundation X owns 10 percent of 
corporation Y's voting stock, which is traded on the New York Stock 
Exchange. Disqualified persons with respect to X own an additional 40 
percent of such voting stock. X is on a calendar year basis. Prior to 
January 1, 1975, X privately sold its entire 10 percent for cash to B, a 
disqualified person, at the price quoted on the stock exchange at the 
close of the day less commissions. Since the 10 percent owned by X would 
constitute excess business holdings without the application of section 
4943(c) (2)(C) or (4), the disposition will not constitute an act of 
self-dealing.
    Example 2. Assume the facts as stated in example (1), except that 
the only stock of corporation Y which X owns is 1.5 percent of Y's 
voting stock. Since the 1.5 percent owned by X would constitute excess 
business holdings without the application of section 4943(c) (2)(C) or 
(4), the disposition of the stock to B for cash will not constitute an 
act of self-dealing.
    Example 3. Assume the facts as stated in example (1), except that B, 
instead of paying cash as consideration for the stock, issued a 10-year 
secured promissory note as consideration for the stock. The issuance of 
such promissory note will not be treated as an act of self-dealing until 
taxable years beginning after December 31, 1979, unless such issuance 
would have been a prohibited transaction under section 503(b), or unless 
the transaction does not remain throughout its life at least as 
favorable as an arm's-length contract negotiated currently. See 
paragraph (c) of this section.

    (c) Existing leases and loans--(1) In general. Under section 
101(1)(2)(C) of the Tax Reform Act of 1969 (83 Stat. 533), the leasing 
of property or the lending of money (or other extension of credit) 
between a disqualified person and a private foundation pursuant to a 
binding contract which was in effect on October 9, 1969 (or pursuant to 
a renewal or modification of such a contract, as described in 
subparagraph (2) of this paragraph), shall not be an act of self-dealing 
until taxable years beginning after December 31, 1979, if:
    (i) At the time the contract was executed, such contract was not a 
prohibited transaction (within the meaning of section 503(b) or the 
corresponding provisions of prior law), and
    (ii) The leasing or lending of money (or other extension of credit) 
remains throughout the term of the lease or extension of credit at least 
as favorable as a current arm's-length transaction with an unrelated 
person.
    (2) Renewal or modification of existing contracts. A renewal or a 
modification of an existing contract is referred to in subparagraph (1) 
of this paragraph only if any modifications of the terms of such 
contract are not substantial and the relative advantages of the modified 
contract compared with contracts entered into at arm's-length with an 
unrelated person at the time of the renewal or modification are at least 
as favorable to the private foundation as the relative advantages of the 
original contract compared with contracts entered into at arm's-length 
with an unrelated person at the time of execution of the original 
contract. Such renewal or modification need not be provided

[[Page 63]]

for in the original contract; it may take place before or after the 
expiration of the original contract and at any time before the first day 
of the first taxable year of the private foundation beginning after 
December 31, 1979. Where, in a normal commercial setting, an unrelated 
party in the position of a private foundation could be expected to 
insist upon a renegotiation or termination of a binding contract, the 
private foundation must so act. Thus, for example, if a disqualified 
person leases office space from a private foundation on a month-to-month 
basis, and a party in the position of the private foundation could be 
expected to renegotiate the rent required in such contract because of a 
rise in the fair market value of such office space, the private 
foundation must so act in order to avoid participation in an act of 
self-dealing. Where the private foundation has no right to insist upon 
renegotiation, an act of self-dealing shall occur if the terms of the 
contract become less favorable to the foundation than an arm's-length 
contract negotiated currently, unless:
    (i) The variation from current fair market value is de minimis, or
    (ii) The contract is renegotiated by the foundation and the 
disqualified person so that the foundation will receive no less than 
fair market value. For purposes of subdivision (i) of this subparagraph 
de minimis ordinarily shall be no more than one-half of 1 percent in the 
rate of return in the case of a loan, or 10 percent of the rent in the 
case of a lease.
    (3) Example. The provisions of subparagraphs (1) and (2) of this 
paragraph may be illustrated by the following example.

    Example. Under a binding contract entered into on January 1, 1964, 
X, a private foundation, leases a building for 10 years from Z, a 
disqualified person. At the time the contract was executed, the lease 
was not a ``prohibited transaction'' within the meaning of section 
503(b), since the rent charged X was only 50 percent of the rent which 
would have been charged in an arm's-length transaction with an unrelated 
person. On January 1, 1974, X renewed the lease for 5 additional years. 
The terms of the renewal agreement provided for a 20 percent increase in 
the amount of rent charged X. However, at the time of such renewal, the 
rent which would have been charged in an arm's-length transaction had 
also increased by 20 percent from that of 1964. The renewal agreement 
shall not be treated as an act of self-dealing.

    (4) Certain exchanges of stock or securities for bonds, debentures 
or other indebtedness. (i) In the case of a transaction described in 
paragraph (a) or (b) of this section or paragraph (d) of Sec. 
53.4941(d)-3, where a bond, debenture, or other indebtedness of a 
disqualified person is acquired by a private foundation in exchange for 
stock or securities which it held on October 9, 1969, and at all times 
thereafter, such indebtedness shall be treated as an extension of credit 
pursuant to a binding contract in effect on October 9, 1969, to which 
this paragraph applies. Thus, so long as the extension of credit remains 
at least as favorable as an arm's-length transaction with an unrelated 
person and neither the acquisition of the securities which were 
exchanged for the indebtedness nor the exchange of such securities for 
the indebtedness was a prohibited transaction within the meaning of 
section 503(b) (or the corresponding provisions of prior law) at the 
time of such acquisition, such extension of credit shall not be an act 
of self-dealing until taxable years beginning after December 31, 1979.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. Assume the facts as stated in example (2) of Sec. 
53.4941 (d)-3 (d)(2), except that the preferred stock was held by Y on 
October 9, 1969, and at all times thereafter until the redemption 
occurred on January 2, 1972. In addition, assume that the acquisition of 
the preferred stock was not a prohibited transaction within the meaning 
of section 503(b) at the time of such acquisition and the exchange of 
the preferred stock for the debentures would not have been a prohibited 
transaction within the meaning of section 503(b). For 1973 through 1979, 
the extension of credit arising from the holding of the debentures is 
not an act of self-dealing so long as the extension of credit remains at 
least as favorable as an arm's-length transaction with an unrelated 
person. See, however, example (3) of Sec. 53.4941 (e)-1 (e)(1)(ii).
    Example 2. Assume the same facts as stated in example (1) of Sec. 
53.4941 (d)-4 (b)(4), except that private foundation X sold its entire 
10 percent of corporation Y's voting stock in exchange for Y's secured 
notes which mature on December 31, 1985. For taxable years beginning 
before January 1, 1980, the extension

[[Page 64]]

of credit arising from the holding of such notes by X is not an act of 
self-dealing so long as the extension of credit remains at least as 
favorable as an arm's-length transaction with an unrelated person and 
neither the acquisition of the securities which were exchanged for the 
indebtedness nor the exchange of such securities for the indebtedness 
was a prohibited transaction within the meaning of section 503(b) (or 
the corresponding provisions of prior law). Under Sec. 53.4941(e)-1, a 
new extension of credit occurs on the first day of each taxable year in 
which an indebtedness is outstanding; therefore, if the secured notes 
are held by X after December 31, 1979, a new extension of credit not 
excepted from the definition of an act of self-dealing will occur on the 
first day of the first taxable year beginning after December 31, 1979, 
and on the first day of each succeeding taxable year in which X holds 
such secured notes.

    (d) Sharing of goods, services, or facilities before January 1, 
1980. (1) Under section 101(1)(2)(D) of the Tax Reform Act of 1969 (83 
Stat. 533), the use (other than leasing) of goods, services, or 
facilities which are shared by a private foundation and a disqualified 
person shall not be an act of self-dealing until taxable years beginning 
after December 31, 1979, if:
    (i) The use is pursuant to an arrangement in effect before October 
9, 1969, and at all times thereafter;
    (ii) The arrangement was not a prohibited transaction (within the 
meaning of sec. 503(b) or the corresponding provisions of prior law) at 
the time it was made; and
    (iii) The arrangement would not be a prohibited transaction if 
section 503(b) continued to apply.

For purposes of this paragraph, such arrangement need not be a binding 
contract.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. In 1964 X, a private foundation, and B, a disqualified 
person, arranged for the sharing of computer time in B's son's company 
for a 10-year period commencing January 1, 1965. B's son has the 
unilateral right to terminate the arrangement at any time. X uses the 
computer facilities in connection with an analysis of its grant-making 
activities, while B's use is related to his business affairs. Both X and 
B make reasonable fixed payments to the computer company based on the 
number of hours of computer use and comparable to fees charged in arm's-
length transactions with unrelated parties. The company imposes a 
maximum limit per month on the sum of the number of hours for which X 
and B use the computer facilities. Under these circumstances, the 
sharing of computer time is not an act of self-dealing.

    (e) Use of certain property acquired before October 9, 1969. (1) 
Under section 101(1)(2)(E) of the Tax Reform Act of 1969 (83 Stat. 533), 
the use of property in which a private foundation and a disqualified 
person have a joint or common interest will not be an act of self-
dealing if the interests of both in such property were acquired before 
October 9, 1969.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. Prior to October 9, 1969, C, a disqualified person, gave 
beachfront property to private foundation X for use as a recreational 
facility for underprivileged, inner-city children during the summer 
months. However, C retained the right to use such property for his life. 
The use of such property by C or X is not an act of self-dealing.

    (f) Disposition of leased property--(1) In general. Under section 
101(l)(2)(F) of the Tax Reform Act of 1969, as amended by the Tax Reform 
Act of 1976 (90 Stat. 1713), the sale, exchange or other disposition 
(other than by lease) to a disqualified person of property being leased 
to the disqualified person by a private foundation is not an act of 
self-dealing if:
    (i) The private foundation is leasing substantially all of the 
property to the disqualified person under a lease to which paragraph (c) 
of this section applies;
    (ii) The disposition occurs after October 4, 1976, and before 
January 1, 1978; and
    (iii) The disposition satisfies the requirements of paragraph (f)(2) 
of this section.
    (2) Terms of disposition. Paragraph (f)(1) of this section applies 
only if:
    (i) The private foundation receives an amount that equals or exceeds 
the fair market value of the property either at the time of the 
disposition or at the time (after June 30, 1976) the contract for such 
disposition was executed;
    (ii) In computing the fair market value of the property, no 
diminution of that value results from the fact that

[[Page 65]]

the property is subject to any lease to disqualified persons; and
    (iii) At the time with respect to which paragraph (f)(2)(i) of this 
section is applied, the transaction would not have constituted a 
prohibited transaction within the meaning of section 503(b) or the 
corresponding provisions of prior law if those provisions had been 
applied at the time of the transaction.

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 7678, 45 FR 
12416, Feb. 26, 1980]



Sec. 53.4941(e)-1  Definitions.

    (a) Taxable period--(1) In general. For purposes of any act of self-
dealing, the term ``taxable period'' means the period beginning with the 
date on which the act of self-dealing occurs and ending on the earliest 
of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed by section 4941(a)(1),
    (ii) The date on which correction of the act of self-dealing is 
completed, or
    (iii) The date on which the tax imposed by section 4941(a)(1) is 
assessed.
    (2) Date of occurrence. An act of self-dealing occurs on the date on 
which all the terms and conditions of the transaction and the 
liabilities of the parties have been fixed. Thus, for example, if a 
private foundation gives a disqualified person a binding option on June 
15, 1971, to purchase property owned by the foundation at any time 
before June 15, 1972, the act of self-dealing has occurred on June 15, 
1971. Similarly, in the case of a conditional sales contract, the act of 
self-dealing shall be considered as occurring on the date the property 
is transferred subject only to the condition that the buyer make payment 
for receipt of such property.
    (3) Special rule. Where a notice of deficiency referred to in 
subparagraph (1)(i) of this paragraph is not mailed because a waiver of 
the restrictions on assessment and collection of a deficiency has been 
accepted, or because the deficiency is paid, the date of filing of the 
waiver or the date of such payment, respectively, shall be treated as 
the end of the taxable period.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. On July 16, 1970, F, a manager of private foundation X 
acting on behalf of the foundation, knowing his act to be one of self-
dealing, willfully and without reasonable cause engaged in an act of 
self-dealing by selling certain real estate to A, a disqualified person. 
On March 25, 1973, the Internal Revenue Service mailed a notice of 
deficiency to A with respect to the tax imposed on the sale under 
section 4941(a)(1). The taxable period with respect to the act of self-
dealing for both A and F is July 16, 1970, through March 25, 1973.
    Example 2. Assume the facts as stated in example (1), except that 
the act of self-dealing is corrected by A on March 17, 1971. The taxable 
period with respect to the act of self-dealing for both A and F is July 
16, 1970, through March 17, 1971.
    Example 3. Assume the facts as stated in example (1), except that on 
August 20, 1972, A files a waiver of the restrictions on assessment and 
collection of the tax imposed on the sale under section 4941(a)(1) which 
is accepted. The taxable period with respect to the act of self-dealing 
for both A and F is July 16, 1970, through August 20, 1972.

    (b) Amount involved--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, for purposes of any act of self-
dealing, the term ``amount involved'' means the greater of the amount of 
money and the fair market value of the other property given or the 
amount of money and the fair market value of the other property 
received.
    (2) Exceptions. (i) In the case of the payment of compensation for 
personal services to persons other than Government officials, the amount 
involved shall be only the excess compensation paid by the private 
foundation.
    (ii) Where the use of money or other property is involved, the 
amount involved shall be the greater of the amount paid for such use or 
the fair market value of such use for the period for which the money or 
other property is used. Thus, for example, in the case of a lease of a 
building by a private foundation to a disqualified person, the amount 
involved is the greater of the amount of rent received by the private 
foundation from the disqualified person or the fair rental value of the 
building for the period such building is used by the disqualified 
person.
    (iii) In cases in which a transaction would not have been an act of 
self-dealing had the private foundation received fair market value, the 
amount involved

[[Page 66]]

is the excess of the fair market value of the property transferred by 
the private foundation over the amount which the private foundation 
receives, but only if the parties have made a good faith effort to 
determine fair market value. For purposes of this subdivision a good 
faith effort to determine fair market value shall ordinarily have been 
made where:
    (a) The person making the valuation is not a disqualified person 
with respect to the foundation and is both competent to make the 
valuation and not in a position, whether by stock ownership or 
otherwise, to derive an economic benefit from the value utilized, and
    (b) The method utilized in making the valuation is a generally 
accepted method for valuing comparable property, stock, or securities 
for purposes of arm's-length business transactions where valuation is a 
significant factor.


See section 4941(d)(2)(F) and Sec. Sec. 53.4941(d)-1(b)(3), 53.4941(d)-
3 (d)(1) and 53.4941(d)-4(b). Thus, for example, if a corporation which 
is a disqualified person with respect to a private foundation 
recapitalizes in a transaction which would be described in section 
4941(d)(2)(F) but for the fact that the private foundation receives new 
stock worth only $95,000 in exchange for the stock which it previously 
held in the corporation and which has a fair market value of $100,000 at 
the time of the recapitalization, the amount involved would be $5,000 
($100,000--$95,000) if there had been a good faith attempt to value the 
stock. Similarly, if an estate enters into a transaction with a 
disqualified person with respect to a foundation and such transaction 
would be described in Sec. 53.4941(d)-1(b)(3) but for the fact that the 
estate receives less than fair market value for the property exchanged, 
the amount involved is the excess of the fair market value of the 
property the estate transfers to the disqualified person over the money 
and the fair market value of the property received by the estate.
    (3) Time for determining fair market value. The fair market value of 
the property or the use thereof, as the case may be, shall be determined 
as of the date on which the act of self-dealing occurred in the case of 
the initial taxes imposed by section 4941(a) and shall be the highest 
fair market value during the taxable period in the case of the 
additional taxes imposed by section 4941(b).
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, a disqualified person with respect to private 
foundation M, uses an airplane owned by M on June 15 and June 16, 1970, 
for a 2-day trip to New York City on personal business and pays M $500 
for the use of such airplane. The fair rental value for the use of the 
airplane for those 2 days is $3,000. For purposes of section 4941(a), 
the amount involved with respect to the act of self-dealing is $3,000.
    Example 2. On April 10, 1970, B, a manager of private foundation P, 
borrows $100,000 from P at 6 percent interest per annum. Both principal 
and interest are to be paid 1 year from the date of the loan. The fair 
market value of the use of the money on April 10, 1970, is 10 percent 
per annum. Six months later, B and P terminate the loan, and B repays 
the $100,000 principal plus $3,000 ($100,000x6 percent for one-half 
year) interest. For purposes of section 4941(a), the amount involved 
with respect to the act of self-dealing is $5,000 ($100,000x10 percent 
for one-half year) for each year or partial year in the taxable period.
    Example 3. C, a substantial contributor to private foundation S, 
leases office space in a building owned by S for $3,600 for 1 year 
beginning on January 1, 1971. The fair rental value of the building for 
a 1-year lease on January 1, 1971, is $5,600. On December 31, 1971, the 
lease is terminated. For purposes of section 4941(a), the amount 
involved with respect to the act of self-dealing is $5,600 for each year 
or partial year in the taxable period.
    Example 4. D, a disqualified person with respect to private 
foundation T, purchases 100 shares of stock from T for $5,000 on June 
15, 1982. The fair market value of the 100 shares of stock on that date 
is $4,800. D sells the 100 shares of stock on December 20, 1983, for 
$6,000. On December 27, 1983, a notice of deficiency with respect to the 
taxes imposed under subsections (a) and (b) of section 4941 is mailed to 
D and the taxable period ends. D fails to correct during the taxable 
period. Between June 15, 1982, and the end of the taxable period, the 
stock was quoted on the New York Stock Exchange at a high of $67 per 
share. The amount involved with respect to the tax imposed under 
subsection (a) is $5,000, and the amount involved with respect to the 
tax imposed under subsection (b) for failure to correct is $6,700 (100 
shares at $67 per share), the highest fair market value during the 
taxable period.

[[Page 67]]

    Example 5. Corporation M, a disqualified person with respect to 
private foundation V, redeems all of its Class B common stock, some of 
which is held by V. The redemption of V's stock would be described in 
section 4941(d)(2)(F) but for the fact that V receives only $95,000 in 
exchange for stock which has a fair market value of $100,000 at the time 
of the transaction. The $95,000 value of V's stock, which is not 
publicly traded, was determined by investment bankers in accordance with 
accepted methods of valuation that would be utilized if the M stock held 
by V were to be offered for sale to the public. Therefore, the amount 
involved with respect to the transaction will ordinarily be limited to 
$5,000 ($100,000--$95,000).

    (c) Correction--(1) In general. Correction shall be accomplished by 
undoing the transaction which constituted the act of self-dealing to the 
extent possible, but in no case shall the resulting financial position 
of the private foundation be worse than that which it would be if the 
disqualified person were dealing under the highest fiduciary standards. 
For example, where a disqualified person sells property to a private 
foundation for cash, correction may be accomplished by recasting the 
transaction in the form of a gift by returning the cash to the 
foundation. Subparagraphs (2) through (6) of this paragraph illustrate 
the minimum standards of correction in the case of certain specific acts 
of self-dealing. Principles similar to the principles contained in such 
subparagraphs shall be applied with respect to other acts of self-
dealing. Any correction pursuant to this paragraph and section 4941 
shall not be an act of self-dealing.
    (2) Sales by foundation. (i) In the case of a sale of property by a 
private foundation to a disqualified person for cash, undoing the 
transaction includes, but is not limited to, requiring recission of the 
sale where possible. However, in order to avoid placing the foundation 
in a position worse than that in which it would be if rescission were 
not required, the amount returned to the disqualified person pursuant to 
the rescission shall not exceed the lesser of the cash received by the 
private foundation or the fair market value of the property received by 
the disqualified person. For purposes of the preceding sentence, fair 
market value shall be the lesser of the fair market value at the time of 
the act of self-dealing or the fair market value at the time of 
rescission. In addition to rescission, the disqualified person is 
required to pay over to the private foundation any net profits he 
realized after the original sale with respect to the property he 
received from the sale. Thus, for example, the disqualified person must 
pay over to the foundation any income derived by him from the property 
he received from the original sale to the extent such income during the 
correction period exceeds the income derived by the foundation during 
the correction period from the cash which the disqualified person 
originally paid to the foundation.
    (ii) If, prior to the end of the correction period, the disqualified 
person resells the property in an arm's-length transaction to a bona 
fide purchaser who is not the foundation or another disqualified person, 
no rescission is required. In such case, the disqualified person must 
pay over to the foundation the excess (if any) of the greater of the 
fair market value of such property on the date on which correction of 
the act of self-dealing occurs or the amount realized by the 
disqualified person from such arm's length resale over the amount which 
would have been returned to the disqualified person pursuant to 
subdivision (i) of this subparagraph if rescission had been required. In 
addition, the disqualified person is required to pay over to the 
foundation any net profits he realized, as described in subdivision (i) 
of this subparagraph.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On July 1, 1970, private foundation M sold a painting to 
A, a disqualified person, for $5,000, in a transaction not within any of 
the exceptions to self-dealing. The fair market value of the painting on 
such date was $6,000. On March 25, 1971, the painting is still owned by 
A and has a fair market value of $7,200. A did not derive any income as 
a result of purchasing the painting. In order to correct the act of 
self-dealing under this subparagraph on March 25, 1971, the sale must be 
rescinded by the return of the painting to M. However, pursuant to such 
rescission, M must not pay A more than $5,000, the original 
consideration received by M.
    Example 2. Assume the facts as stated in Example (1), except that A 
sold the painting on December 15, 1970, in an arm's-length transaction 
to C, a bona fide purchaser who

[[Page 68]]

is not a disqualified person, for $6,100. In addition, assume that the 
fair market value of the painting on March 25, 1971, is $7,600. In order 
to correct the act of self-dealing under this subparagraph on March 25, 
1971, A must pay M $2,600 ($7,600, the fair market value at the time of 
correction, less $5,000, the amount which would have been returned to A 
if rescission had been required). Since the painting was sold to C in an 
arm's-length transaction prior to correction, no rescission is required.

    (3) Sales to foundation. (i) In the case of a sale of property to a 
private foundation by a disqualified person for cash, undoing the 
transaction includes, but is not limited to, requiring rescission of the 
sale where possible. However, in order to avoid placing the foundation 
in a position worse than that in which it would be if rescission were 
not required, the amount received from the disqualified person pursuant 
to the rescission shall be the greatest of the cash paid to the 
disqualified person, the fair market value of the property at the time 
of the original sale, or the fair market value of the property at the 
time of rescission. In addition to rescission, the disqualified person 
is required to pay over to the private foundation any net profits he 
realized after the original sale with respect to the consideration he 
received from the sale. Thus, for example, the disqualified person must 
pay over to the foundation any income derived by him from the cash he 
received from the original sale to the extent such income during the 
correction period exceeds the income derived by the foundation during 
the correction period from the property which the disqualified person 
originally transferred to the foundation.
    (ii) If, prior to the end of the correction period, the foundation 
resells the property in an arm's-length transaction to a bona fide 
purchaser who is not a disqualified person, no rescission is required. 
In such case, the disqualified person must pay over to the foundation 
the excess (if any) of the amount which would have been received from 
the disqualified person pursuant to subdivision (i) of this 
subparagraph, if recission had been required over the amount realized by 
the foundation upon resale of the property. In addition, the 
disqualified person is required to pay over to the foundation any net 
profits he realized, as described in subdivision (i) of this 
subparagraph.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On February 10, 1972, D, a disqualified person with 
respect to private foundation P, sells 100 shares of X stock to P for 
$2,500 in a transaction which does not fall within any of the exceptions 
to selfdealing. The fair market value of the 100 shares of X stock on 
February 10, 1972, is $3,200. On June 1, 1973, the 100 shares of X stock 
have a fair market value of $2,900. From February 10, 1972, through June 
1, 1973, P has received dividends of $90 from the stock, and D has 
received interest of $300 from the $2,500 which D received as 
consideration for the stock. In order to correct the act of self-dealing 
under this subparagraph on June 1, 1973, the sale must be rescinded by 
the return of the stock to D. However, pursuant to such rescission, D 
must pay P $3,200, the fair market value of the stock on the date of 
sale. In addition, D must pay P $210, the amount of income derived by D 
during the correction period from the $2,500 received from P ($300) 
minus the income derived by P during the correction period from the 
stock sold to P ($90).
    Example 2. Assume the facts as stated in Example (1), except that on 
September 1, 1972, P sells the 100 shares of X stock to E, a bona fide 
purchaser who is not a disqualified person, in an arm's-length 
transaction for $2,750. Assume further that P has not received any 
dividends from the stock prior to the sale to E, but that P receives 
interest of $260 from the $2,750 received as consideration for the stock 
for the period from September 1, 1972, to June 1, 1973. In order to 
correct the act of self-dealing under this subparagraph on June 1, 1973, 
D must pay P $450 ($3,200, the amount which would have been received 
from D if rescission had been required, less $2,750, the amount realized 
by P from the sale to E). In addition, D must pay P $40, the amount of 
income derived by D during the correction period from the $2,500 
received from P ($300) minus the income derived by P during the 
correction period from the stock sold to P ($260 from the $2,750 
received as consideration for the stock). Since the stock was sold to E 
in an arm's-length transaction prior to correction, no rescission is 
required.

    (4) Use of property by a disqualified person. (i) In the case of the 
use by a disqualified person of property owned by a private foundation, 
undoing the transaction includes, but is not limited to, terminating the 
use of such property. In addition to termination, the disqualified 
person must pay the foundation:

[[Page 69]]

    (a) The excess (if any) of the fair market value of the use of the 
property over the amount paid by the disqualified person for such use 
until such termination, and
    (b) The excess (if any) of the amount which would have been paid by 
the disqualified person for the use of the property on or after the date 
of such termination, for the period such disqualified person would have 
used the property (without regard to any further extensions or renewals 
of such period) if such termination had not occurred, over the fair 
market value of such use for such period.

In applying (a) of this subdivision the fair market value of the use of 
property shall be the higher of the rate (that is, fair rental value per 
period in the case of use of property other than money or fair interest 
rate in the case of use of money) at the time of the act of self-dealing 
(within the meaning of paragraph (e)(1) of this section) or such rate at 
the time of correction of such act of self-dealing. In applying (b) of 
this subdivision the fair market value of the use of property shall be 
the rate at the time of correction.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. On January 1, 1972, private foundation S rented the third 
story of its office building to A, a disqualified person, for 1 year at 
an annual rent of $10,000, in a transaction not within any of the 
exceptions to self-dealing. Both S and A are on the calendar year basis. 
The fair rental value of such office space for a 1-year period on 
January 1, 1972, is $12,000. On June 30, 1972, the fair rental value of 
such office space for a 1-year period is $13,000. In order to correct 
the act of self-dealing under this subparagraph on June 30, 1972, A must 
terminate his use of the property. In addition, A must pay S $1,500, the 
excess of $6,500 (the fair rental value for 6 months as of June 30, 
1972) over $5,000 (the amount paid to S from Jan. 1, 1972, to June 30, 
1972).
    Example 2. On January 1, 1972, private foundation R rented the 
fourth story of its office building to B, a disqualified person, for 1 
year at an annual rent of $10,000, in a transaction not included in any 
of the exceptions to self-dealing. Both R and B are on the calendar year 
basis. On January 1, 1973, B continues to rent the office space as a 
periodic tenant paying his rent monthly at an annual rate of $10,000. 
The fair rental value of such office space for a 1-year period on 
January 1, 1972, is $12,000, and as of January 1, 1973, is $1,250 per 
month. As of December 31, 1973, the fair rental value of such office 
space is $14,000 for a 1-year period and $1,200 on a monthly basis. In 
order to correct his acts of self-dealing (within the meaning of 
paragraph (e)(1) of this section) under this subparagraph on December 
31, 1973, B must terminate his use of the property. In addition, B must 
pay R $9,000, $4,000 for his use of the property for 1972 (the excess of 
$14,000, the fair rental value for 1 year as of Dec. 31, 1973, over 
$10,000, the amount B paid R for his use of the property for 1972) and 
$5,000 for his use of the property for 1973 (the excess of $15,000, the 
fair rental value for 12 months as of Jan. 1, 1973, over $10,000, the 
amount B paid R for his use of the property for 1973).
    Example 3. B, a substantial contributor to private foundation T, 
leases office space in a building owned by T for $5,000 for 1 year 
beginning on November 10, 1972, in a transaction not included in any of 
the exceptions to self-dealing. The fair rental value of the building 
for a 1-year period on November 10, 1972, is $4,000. On May 10, 1973, 
the fair rental value of the building for the remaining period of the 
lease is $2,200. In order to correct the acts of self-dealing under this 
subparagraph on May 10, 1973, B and T must terminate the lease. In 
addition, B must pay T $300 (the excess of $2,500, the amount which 
would have been paid by B for the remaining period of the lease if it 
had not been terminated, over $2,200, the fair rental value at the time 
of correction for the remaining period of the lease).

    (5) Use of property by a private foundation. (i) In the case of the 
use by a private foundation of property owned by a disqualified person, 
undoing the transaction includes, but is not limited to, terminating the 
use of such property. In addition to termination, the disqualified 
person must pay the foundation:
    (a) The excess (if any) of the amount paid to the disqualified 
person for such use until such termination over the fair market value of 
the use of the property, and
    (b) The excess (if any) of the fair market value of the use of the 
property, for the period the foundation would have used the property 
(without regard to any further extensions or renewals of such period) if 
such termination had not occurred, over the amount which would have been 
paid to the disqualified person on or after the date of such termination 
for such use for such period.

[[Page 70]]


In applying (a) of this subdivision the fair market value of the use of 
property shall be the lesser of the rate (that is, fair rental value per 
period in the case of use of property other than money or fair interest 
rate in the case of use of money) at the time of the act of self-dealing 
(within the meaning of paragraph (e)(1) of this section) or such rate at 
the time of correction of such act of self-dealing. In applying (b) of 
this subdivision the fair market value of the use of property shall be 
the rate at the time of correction.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. On July 1, 1972, private foundation X leases office space 
in a building owned by C, a disqualified person, for 1 year at an annual 
rent of $6,000. Both X and C are on the calendar year basis. The fair 
rental value of such office space for a 1-year period as of July 1, 
1972, is $4,200. As of January 1, 1973, the fair rental value of such 
office space for a 1-year period is $5,400, and as of June 30, 1973, the 
fair rental value of such office space for a 1-year period is $4,800. In 
order to correct his acts of self-dealing (within the meaning of 
paragraph (e)(1) of this section) under this subparagraph on June 30, 
1973, C must terminate X's use of the property. In addition, C must pay 
X $1,500, $900 (the excess of $3,000, the amount paid to C from July 1, 
1972, through December 31, 1972, over $2,100, the fair rental value for 
6 months as of July 1, 1972) plus $600 (the excess of $3,000, the amount 
paid to C from January 1, 1973, through June 30, 1973, over $2,400, the 
fair rental value for 6 months as of June 30, 1973).
    Example 2. On April 1, 1973, D, a disqualified person with respect 
to private foundation Y, loans $100,000 to Y at 6 percent interest per 
annum. Both principal and interest are to be paid on April 1, 1978. The 
fair market value of the use of the money on April 1, 1973, is 9 percent 
per annum. On April 1, 1974, D and Y terminate the loan. On such date, 
the fair market value of the use of $100,000 is 10 percent per annum. In 
order to correct the act of self-dealing on April 1, 1974, in addition 
to the termination of the loan from D to Y, D must pay Y $16,000, the 
excess of $40,000 ($100,000x10 percent, the fair market value of the use 
determined at the time of correction, from April 1, 1974, to April 1, 
1978) over $24,000 (the amount of interest Y would have paid to D from 
April 1, 1974, to April 1, 1978, if the loan from D to Y had not been 
terminated).

    (6) Payment of compensation to a disqualified person. In the case of 
the payment of compensation by a private foundation to a disqualified 
person for the performance of personal services which are reasonable and 
necessary to carry out the exempt purpose of such foundation, undoing 
the transaction requires that the disqualified person pay to the 
foundation any amount which is excessive. However, termination of the 
employment or independent contractor relationship is not required.
    (7) Special rule for correction of valuation errors. (i) In the case 
of a transaction described in paragraph (b)(2)(iii) of this section, a 
``correction'' of the act of self-dealing shall ordinarily be deemed to 
occur if the foundation is paid an amount of money equal to the amount 
involved (as defined in paragraph (b)(2)(iii) of this section) plus such 
additional amounts as are necessary to compensate it for the loss of the 
use of the money or other property during the period commencing on the 
date of the act of self-dealing and ending on the date the transaction 
is corrected pursuant to this subparagraph.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. Assume the same facts as in example (5) of paragraph (b)(4) 
of this section. Such transaction shall be considered as corrected by a 
payment of $5,000 by M to V, together with an additional payment to V of 
an amount equal to the interest which V could have obtained on $5,000 
for the period commencing on the date of the redemption and ending on 
the date the act is corrected.

    (d) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963 (e), see 
section 4961 (a), and the regulations thereunder.
    (e) Act of self-dealing--(1) Number of acts; use of money or 
property--(i) In general. If a transaction between a private foundation 
and a disqualified person is determined to be self-dealing (as defined 
in section 4941(d)), for purposes of section 4941 there is generally one 
act of self-dealing. For the date on which such act is treated as 
occurring, see paragraph (a)(2) of this section. If, however, such 
transaction relates to the leasing of property, the lending of money or 
other extension of credit, other use of money or property, or payment of 
compensation, the transaction will generally be treated (for purposes

[[Page 71]]

of section 4941 but not section 507 or section 6684) as giving rise to 
an act of self-dealing on the day the transaction occurs plus an act of 
self-dealing on the first day of each taxable year or portion of a 
taxable year which is within the taxable period and which begins after 
the taxable year in which the transaction occurs.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On August 31, 1970, X, a private foundation, sells a 
building to A, a disqualified person with respect to X. A is on the 
calendar year basis. Under these circumstances, the transaction between 
A and X is one act of self-dealing which is treated for purposes of 
section 4941 as occurring on August 31, 1970.
    Example 2. Assume the facts as stated in example (1), except that, 
instead of selling the building to A, X leases the building to A for a 
term of 4 years beginning July 31, 1970, at an annual rental of $12,000. 
The fair rental value of the building is also $12,000 per annum as of 
July 31, 1970, and throughout the next 4 years. This transaction is 
corrected on September 30, 1973, in accordance with paragraph (c)(4) of 
this section. Under these circumstances, the transaction between A and X 
constitutes four separate acts of self-dealing, which are treated for 
purposes of section 4941 as occurring on July 31, 1970, January 1, 1971, 
January 1, 1972, and January 1, 1973. Consequently, there are four 
taxable periods. The first taxable period is from July 31, 1970, to 
September 30, 1973; the second is from January 1, 1971, to September 30, 
1973; the third is from January 1, 1972, to September 30, 1973; and the 
fourth is from January 1, 1973, to September 30, 1973. For purposes of 
the initial taxes in section 4941(a), the amount involved is $5,000 for 
the first taxable period, $12,000 for the second, $12,000 for the third, 
and $9,000 for the fourth. The initial taxes to be paid by A are thus 
$1,000 ($5,000x5%x4 taxable years or partial taxable years in the 
taxable period) for the first act; $1,800 ($12,000x5%x3) for the second 
act; $1,200 ($12,000x5%x2) for the third act; and $450 ($9,000x5%x1) for 
the fourth act.
    Example 3. Assume the facts as stated in example (1) of Sec. 
53.4941(d)-4(c)(4)(ii). If the debentures are held by Y after December 
31, 1979, the extension of credit will not be excepted from the 
definition of an act of self-dealing, because an act of self-dealing 
will be treated (for purposes of section 4941) as occurring on January 
1, 1980.

    (2) Number of acts; joint participation by disqualified persons--(i) 
In general. If joint participation in a transaction by two or more 
disqualified persons constitutes self-dealing (such as a joint sale of 
property to a private foundation or joint use of its money or property), 
such transaction shall generally be treated as a separate act of self-
dealing with respect to each disqualified person for purposes of section 
4941. For purposes of section 507 and, in the case of a foundation 
manager, section 6684, however, such transaction shall be treated as 
only one act of self-dealing. For purposes of this subparagraph, an 
individual and one or more members of his family (within the meaning of 
section 4946(d)) shall be treated as one person, regardless of whether a 
member of the family is a disqualified person not only by reason of 
section 4946(a)(1)(D) but also by reason of another subparagraph of 
section 4946(a)(1). However, the liability imposed on a disqualified 
person and one or more members of his family for joint participation in 
an act of self-dealing shall be joint and several in accordance with 
section 4941(c)(1) and Sec. 53.4941(c)-1(a).
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. Private foundation X permits A, a substantial contributor 
to X, and her spouse, H, to use an automobile owned by X and normally 
used in its foundation activities to travel from State Z to State Y for 
a vacation on December 1, 1971. The automobile is then returned to X 
until December 21, 1971, when X again permits them to use the automobile 
to return to their home in State Z. Under these circumstances, there is 
one act of self-dealing on December 1, 1971, and a second act of self-
dealing on December 21, 1971.
    Example 2. Assume the facts as stated in example (1), except that B 
joined A and H on their vacation and traveled with them both to and from 
State Y. B is a disqualified person with respect to X, but he is not 
related by blood or marriage to A or H. Assume also that X is not paid 
for the use of its automobile, but that the fair rental value during the 
taxable period is $300 (or $100 per person) for a one-way trip between 
State Y and State Z. Under these circumstances, there are four acts of 
self-dealing, two with respect to A and H and two with respect to B. The 
amount involved with respect to A and H is $200 for each act, and the 
amount involved with respect to B is $100 for each act.

    (f) Fair market value. For purposes of Sec. Sec. 53.4941(a)-1 
through 53.4941 (f)-1, fair

[[Page 72]]

market value shall be determined pursuant to the provisions of Sec. 
53.4942(a)-2 (c)(4).

[T.D. 7270, 38 FR 9493, Apr. 17, 1973, as amended by T.D. 8084, 51 FR 
16301, May 2, 1986]



Sec. 53.4941(f)-1  Effective dates.

    (a) In general. Except as provided in paragraph (b) of this section, 
Sec. Sec. 53.4941(a)-1 through 53.4941(e)-1 shall apply to all acts of 
self-dealing engaged in after December 31, 1969.
    (b) Transitional rules--(1) Commitments made prior to January 1, 
1970, between private foundations and government officials. Section 4941 
shall not apply to a payment for one or more purposes described in 
section 170(c) (1) or (2)(B) made on or after January 1, 1970, by a 
private foundation to a government official, if such payment is made 
pursuant to a commitment entered into prior to such date, but only if 
such commitment was made in accordance with the foundation's usual 
practices and is reasonable in amount in light of the purposes of the 
payment. For purposes of this subparagraph, a commitment will be 
considered entered into prior to January 1, 1970, if prior to such date, 
the amount and nature of the payments to be made and the name of the 
payee were entered on the records of the payor, or were otherwise 
adequately evidenced, or the notice of the payment to be received was 
communicated to the payee in writing.
    (2) Special transitional rule. In the case of an act of self-dealing 
engaged in prior to July 5, 1971, section 4941(a) (1) shall not apply 
if:
    (i) The participation (as defined in Sec. 53.4941(a)-1(a)(3)) by 
the disqualified person in such act is not willful and is due to 
reasonable cause (as defined in Sec. 53.4941(a)-1(b) (4) and (5)),
    (ii) The transaction would not be a prohibited transaction if 
section 503(b) applied, and
    (iii) The act is corrected (within the meaning of Sec. 53.4941(e)-
1(c)) within a period ending [insert 90 days after date on which final 
regulations under section 4941 are filed by the Federal Register], 
extended (prior to the expiration of the original period) by any period 
which the Commissioner determines is reasonable and necessary (within 
the meaning of Sec. 53.4941(e)-1(d)) to bring about correction of the 
act of self-dealing.



             Subpart C_Taxes on Failure To Distribute Income

    Source: T.D. 7249, 38 FR 768, Jan. 4, 1973, unless otherwise noted.



Sec. 53.4942(a)-1  Taxes for failure to distribute income.

    (a) Imposition of tax--(1) Initial tax. Except as provided in 
paragraph (b) of this section, section 4942(a) imposes an excise tax of 
15 percent on the undistributed income (as defined in paragraph (a) of 
Sec. 53.4942(a)-2) of a private foundation for any taxable year which 
has not been distributed before the first day of the second (or any 
succeeding) taxable year following such taxable year (if such first day 
falls within the taxable period as defined in paragraph (c)(1) of this 
section). For purposes of section 4942 and this section, the term 
distributed means distributed as qualifying distributions under section 
4942(g). See paragraph (d)(2) of Sec. 53.4942(a)-3 with respect to 
correction of deficient distributions for prior taxable years.
    (2) Additional tax. In any case in which an initial excise tax is 
imposed by section 4942(a) on the undistributed income of a private 
foundation for any taxable year, section 4942(b) imposes an additional 
excise tax on any portion of such income remaining undistributed at the 
close of the correction period (as defined in paragraph (c)(1) of this 
section). The tax imposed by section 4942(b) is equal to 100 percent of 
the amount remaining undistributed at the close of the taxable period.
    (3) Payment of tax. Payment of the excise taxes imposed by section 
4942 (a) or (b) is in addition to, and not in lieu of, making the 
distribution of such undistributed income as required by section 4942. 
See section 507(a)(2) and the regulations thereunder.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which uses the calendar year as 
its taxable year, has at the end of 1981, $50,000 of undistributed 
income (as defined in paragraph (a) of Sec. 53.4942 (a)-2) for 1981. As 
of January 1, 1983,

[[Page 73]]

$40,000 is still undistributed. On August 15, 1983, a notice of 
deficiency with respect to the excise taxes imposed by section 4942 (a) 
and (b) is mailed to M under section 6212 (a) and the taxable period 
ends. Thus, under these facts, an initial excise tax of $6,000 (15 
percent of $40,000) is imposed upon M. An additional excise tax of 
$40,000 (100 percent of $40,000) is imposed by section 4942(b). Under 
section 4961(a), however, if the undistributed income is reduced to zero 
during the correction period, this latter tax will not be assessed, and 
if assessed, it will be abated, and if collected, it will be credited or 
refunded as an overpayment.
    Example 2. Assume the facts as stated in example (1), except that 
the notice of deficiency is mailed to M on September 7, 1984, and as of 
January 1, 1984, only $10,000 of the $50,000 of undistributed income 
with respect to 1981 is undistributed. Therefore, initial excise taxes 
of $6,000 (15 percent of $40,000, M's undistributed income from 1981, as 
of January 1, 1983) and $1,500 (15 percent of $10,000, M's undistributed 
income from 1981 as of January 1, 1984) are imposed by section 4942(a). 
If the $10,000 remains undistributed as of September 7, 1984, the end of 
the taxable period, an additional excise tax of $10,000 (100 percent of 
$10,000, M's undistributed income from 1981, as of September 7, 1984) is 
imposed by section 4942(b).

    (b) Exceptions--(1) In general. The initial excise tax imposed by 
section 4942(a) shall not apply to the undistributed income of a private 
foundation:
    (i) For any taxable year for which it is an operating foundation (as 
defined in section 4942(j)(3) and the regulations thereunder), or
    (ii) To the extent that the foundation failed to distribute any 
amount solely because of incorrect valuation of assets under paragraph 
(c)(4) of Sec. 53.4942(a)-2, if:
    (a) The failure to value the assets properly was not willful and was 
due to reasonable cause,
    (b) Such amount is distributed as qualifying distributions (within 
the meaning of paragraph (a) of Sec. 53.4942 (a)-3) by the foundation 
during the allowable distribution period (as defined in paragraph (c)(2) 
of this section),
    (c) The foundation notifies the Commissioner that such amount has 
been distributed (within the meaning of subdivision (ii)(b) of this 
subparagraph) to correct such failure, and
    (d) Such distribution is treated under paragraph (d)(2) of Sec. 
53.4942(a)-3 as made out of the undistributed income for the taxable 
year for which a tax would (except for this subdivision) have been 
imposed by section 4942(a).
    (2) Improper valuation. For purposes of subparagraph (1)(ii) of this 
paragraph, failure to value an asset properly shall be regarded as ``not 
willful'' and ``due to reasonable cause'' whenever, under all the facts 
and circumstances, the foundation can show that it has made all 
reasonable efforts in good faith to value such an asset in accordance 
with the provisions of paragraph (c)(4) of Sec. 53.4942(a)-2. If a 
foundation, after full disclosure of the factual situation, obtains a 
bona fide appraisal of the fair market value of an asset by a person 
qualified to make such an appraisal (whether or not such a person is a 
disqualified person with respect to the foundation), and such foundation 
relies upon such appraisal, then failure to value the asset properly 
shall ordinarily be regarded as ``not willful'' and ``due to reasonable 
cause''. Notwithstanding the preceding sentence, the failure to obtain 
such a bona fide appraisal shall not, by itself, give rise to any 
inference that a foundation's failure to value an asset properly was 
willful or not due to reasonable cause.
    (3) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. In 1976 M, a private foundation which was established in 
1975 and which uses the calendar year as the taxable year, incorrectly 
values its assets under paragraph (c)(4) of Sec. 53.4942(a)-2 in a 
manner which is not willful and is due to reasonable cause. As a result 
of the incorrect valuation of assets, $20,000 which should be 
distributed with respect to 1976 is not distributed, and as of January 
1, 1978, such amount is still undistributed. On March 29, 1978, a notice 
of deficiency with respect to the excise taxes imposed by section 4942 
(a) and (b) is mailed to M under section 6212(a). On May 5, 1978 (within 
the allowable distribution period), M makes a qualifying distribution of 
$20,000 which is treated under paragraph (d)(2) of Sec. 53.4942(a)-3 as 
made out of M's undistributed income for 1976. M notifies the 
Commissioner of its action. Under the stated facts, an initial excise 
tax of $3,000 (15 percent of $20,000) would (except for the exception 
contained in subparagraph (1)(ii) of this paragraph) have been imposed 
by section 4942(a), but since all of the requirements of such 
subparagraph are satisfied no tax is imposed by section 4942(a).


[[Page 74]]


    (c) Certain periods. For purposes of this section--
    (1) Taxable period. (i) The term ``taxable period'' means, with 
respect to the undistributed income of a private foundation for any 
taxable year, the period beginning with the first day of the taxable 
year and ending on the earlier of:
    (A) The date of mailing of a notice of deficiency under section 
6212(a) with respect to the initial excise tax imposed under section 
4942(a), or
    (B) The date on which the initial excise tax imposed under section 
4942(a) is assessed.

For example, assume M, a private foundation which uses the calendar year 
as the taxable year, has $15,000 of undistributed income for 1981. A 
notice of deficiency is mailed to M under section 6212(a) on June 1, 
1983. With respect to the undistributed income of M for 1981, the 
taxable period began on January 1, 1981, and ended on June 1, 1983.
    (ii) Where a notice of deficiency referred to in subdivision (i) of 
this subparagraph is not mailed because there is a waiver of the 
restrictions on assessment and collection of a deficiency, or because 
the deficiency is paid, the date of filing of the waiver or the date of 
such payment, respectively, shall be treated as the end of the taxable 
period.
    (2) Allowable distribution period. (i) The term ``allowable 
distribution period'' means the period beginning with the first day of 
the first taxable year following the taxable year in which the incorrect 
valuation of foundation assets (described in paragraph (b)(1)(ii) of 
this section) occurred and ending 90 days after the date of mailing of a 
notice of deficiency under section 6212(a) with respect to the initial 
excise tax imposed by section 4942(a). This period shall be extended by 
any period in which a deficiency cannot be assessed under section 
6213(a), and any other period which the Commissioner determines is 
reasonable and necessary to permit a distribution of undistributed 
income under section 4942.
    (ii) Where a notice of deficiency referred to in subdivision (i) of 
this subparagraph is not mailed because there is a waiver of the 
restrictions on assessment and collection of a deficiency, or because 
the deficiency is paid, the date of filing of the waiver or the date of 
such payment, respectively, shall be treated as the end of the allowable 
distribution period.
    (3) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961 (a) and the regulations thereunder.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. In 1975 M, a private foundation which uses the calendar 
year as the taxable year, made an error in valuing its assets which was 
not willful and was due to reasonable cause. The error caused M not to 
distribute $25,000 that should have been distributed with respect to 
1975. On March 1, 1978, a notice of deficiency with respect to the 
excise taxes imposed by section 4942 (a) and (b) was mailed to M under 
section 6212(a). With respect to the undistributed income for 1975, the 
taxable period is the period from January 1, 1975, through March 1, 
1978, and the allowable distribution period is the period from January 
1, 1976, through May 30, 1978 (90 days after the mailing of the notice 
of deficiency).
    Example 2. Assume the facts as stated in example (1), except that 
the Commissioner determines that it is reasonable and necessary to 
extend the period for distribution through June 15, 1978. Thus, the 
allowable distribution period is from January 1, 1976, through June 15, 
1978.

    (d) Effective date. Except as otherwise specifically provided, 
section 4942 and the regulations thereunder shall only apply with 
respect to taxable years beginning after December 31, 1969.

[T.D. 7256, 38 FR 3317, Feb. 7, 1973, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4942(a)-2  Computation of undistributed income.

    (a) Undistributed income. For purposes of section 4942, the term 
``undistributed income'' means, with respect to any private foundation 
for any taxable year as of any time, the amount by which:
    (1) The distributable amount (as defined in paragraph (b) of this 
section) for such taxable year, exceeds
    (2) The qualifying distributions (as defined in Sec. 53.4942(a)-3) 
made before such time out of such distributable amount.
    (b) Distributable amount--(1) In general. For purposes of paragraph 
(a) of this section, the term ``distributable amount'' means:

[[Page 75]]

    (i) For taxable years beginning before January 1, 1982, an amount 
equal to the greater of the minimum investment return (as defined in 
paragraph (c) of this section) or the adjusted net income (as defined in 
paragraph (d) of this section); and
    (ii) For taxable years beginning after December 31, 1981, an amount 
equal to the minimum investment return (as defined in paragraph (c) of 
this section), reduced by the sum of the taxes imposed on such private 
foundation for such taxable year under subtitle A of the Code and 
section 4940, and increased by the amounts received from trusts 
described in subparagraph (2) of this paragraph.
    (2) Certain trust amounts--(i) In general. The distributable amount 
shall be increased by the income portion (as defined in subdivision (ii) 
of this subparagraph) of distributions from trusts described in section 
4947(a)(2) with respect to amounts placed in trust after May 26, 1969. 
If such distributions are made with respect to amounts placed in trust 
both on or before and after May 26, 1969, such distributions shall be 
allocated between such amounts to determine the extent to which such 
distributions shall be included in the foundation's distributable 
amount. For rules relating to the segregation of amounts placed in trust 
on or before May 26, 1969, from amounts placed in trust after such date 
and to the allocation of income derived from such amounts, see paragraph 
(c) (5) of Sec. 53.4947-1.
    (ii) Income portion of distributions to private foundations. For 
purposes of subdivision (i) of this subparagraph, the income portion of 
a distribution from a section 4947(a)(2) trust to a private foundation 
in a particular taxable year of such foundation shall be the greater of:
    (a) The amount of such distribution which is treated as income 
(within the meaning of section 643(b)) of the trust, or
    (b) The guaranteed annuity, or fixed percentage of the fair market 
value of the trust property (determined annually), which the private 
foundation is entitled to receive for such year, regardless of whether 
such amount is actually received in such year or in any prior or 
subsequent year.
    (iii) Limitation. Notwithstanding subdivisions (i) and (ii) of this 
subparagraph, a private foundation shall not be required to distribute a 
greater amount for any taxable year than would have been required 
(without regard to this subparagraph) for such year had the corpus of 
the section 4947(a) (2) trust to which the distribution described in 
subdivision (ii) of this subparagraph is attributable been taken into 
account by such foundation as an asset described in paragraph (c) (1) 
(i) of this section.
    (c) Minimum investment return--(1) In general. For purposes of 
paragraph (b) of this section, the ``minimum investment return'' for any 
private foundation for any taxable year is the amount determined by 
multiplying:
    (i) The excess of the aggregate fair market value of all assets of 
the foundation, other than those described in subparagraph (2) or (3) of 
this paragraph, over the amount of the acquisition indebtedness with 
respect to such assets (determined under section 514(c)(1), but without 
regard to the taxable year in which the indebtedness was incurred), by
    (ii) The applicable percentage (as defined in subparagraph (5) of 
this paragraph) for such year.

For purposes of subdivision (i) of this subparagraph, the aggregate fair 
market value of all assets of the foundation shall include the average 
of the fair market values on a monthly basis of securities for which 
market quotations are readily available (within the meaning of 
subparagraph (4)(i)(a) of this paragraph), the average of the 
foundation's cash balances on a monthly basis (less the cash balances 
excluded from the computation of the minimum investment return by 
operation of subparagraph (3)(iv) of this paragraph), and the fair 
market value of all other assets (except those assets described in 
subparagraph (2) or (3) of this paragraph) for the period of time during 
the taxable year for which such assets are held by the foundation. Any 
determination of the fair market value of an asset required pursuant to 
the provisions of this subparagraph shall

[[Page 76]]

be made in accordance with the rules of subparagraph (4) of this 
paragraph.
    (2) Certain assets excluded. For purposes of this paragraph, the 
assets taken into account in determining minimum investment return shall 
not include the following:
    (i) Any future interest (such as a vested or contingent remainder, 
whether legal or equitable) of a foundation in the income or corpus of 
any real or personal property, other than a future interest created by 
the private foundation after December 31, 1969, until all intervening 
interests in, and rights to the actual possession or enjoyment of, such 
property have expired, or, although not actually reduced to the 
foundation's possession, until such future interest has been 
constructively received by the foundation, as where it has been credited 
to the foundation's account, set apart for the foundation, or otherwise 
made available so that the foundation may acquire it at any time or 
could have acquired it if notice of intention to acquire had been given;
    (ii) The assets of an estate until such time as such assets are 
distributed to the foundation or, due to a prolonged period of 
administration, such estate is considered terminated for Federal income 
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this 
chapter (Income Tax Regulations);
    (iii) Any present interest of a foundation in any trust created and 
funded by another person (see, however, paragraph (b) (2) of this 
section with respect to amounts received from certain trusts described 
in section 4947(a) (2));
    (iv) Any pledge to the foundation of money or property (whether or 
not the pledge may be legally enforced); and
    (v) Any assets used (or held for use) directly in carrying out the 
foundation's exempt purpose.
    (3) Assets used (or held for use) in carrying out the exempt 
purpose--(i) In general. For purposes of subparagraph (2)(v) of this 
paragraph, an asset is ``used (or held for use) directly in carrying out 
the foundation's exempt purpose'' only if the asset is actually used by 
the foundation in the carrying out of the charitable, educational, or 
other similar purpose which gives rise to the exempt status of the 
foundation, or if the foundation owns the asset and establishes to the 
satisfaction of the Commissioner that its immediate use for such exempt 
purpose is not practical (based on the facts and circumstances of the 
particular case) and that definite plans exist to commence such use 
within a reasonable period of time. Consequently, assets which are held 
for the production of income or for investment (for example, stocks, 
bonds, interest-bearing notes, endowment funds, or, generally, leased 
real estate) are not being used (or held for use) directly in carrying 
out the foundation's exempt purpose, even though the income from such 
assets is used to carry out such exempt purpose. Whether an asset is 
held for the production of income or for investment rather than used (or 
held for use) directly by the foundation to carry out its exempt purpose 
is a question of fact. For example, an office building used for the 
purpose of providing offices for employees engaged in the management of 
endowment funds of the foundation is not being used (or held for use) 
directly by the foundation to carry out its charitable, educational, or 
other similar exempt purpose. However, where property is used both for 
charitable, educational, or other similar exempt purposes and for other 
purposes, if such exempt use represents 95 percent or more of the total 
use, such property shall be considered to be used exclusively for a 
charitable, educational, or other similar exempt purpose. If such exempt 
use of such property represents less than 95 percent of the total use, 
reasonable allocation between such exempt and nonexempt use must be made 
for purposes of this paragraph. Property acquired by the foundation to 
be used in carrying out its charitable, educational, or other similar 
exempt purpose may be considered as used (or held for use) directly to 
carry out such exempt purpose even though the property, in whole or in 
part, is leased for a limited period of time during which arrangements 
are made for its conversion to the use for which it was acquired, 
provided such income-producing use of the property does not exceed a 
reasonable period of time. Generally, 1 year shall be deemed to be a 
reasonable period of time for purposes of the immediately preceding 
sentence.

[[Page 77]]

For treatment of the income derived from such income-producing use, see 
paragraph (d)(2)(viii) of this section. Where the income-producing use 
continues beyond a reasonable period of time, the property shall not be 
deemed to be used by the foundation to carry out its charitable, 
educational, or other similar exempt purpose, but, instead, as of the 
time the income-producing use becomes unreasonable, such property shall 
be treated as disposed of within the meaning of paragraph (d)(2)(iii)(b) 
of this section to the extent that the acquisition of the property was 
taken into account as a qualifying distribution (within the meaning of 
paragraph (a)(2) of Sec. 53.4942(a-3) for any taxable year. If, 
subsequently, the property is used by the foundation directly in 
carrying out its charitable, educational, or other similar exempt 
purpose, a qualifying distribution in the amount of its then fair market 
value, determined in accordance with the rules contained in subparagraph 
(4) of this paragraph, shall be deemed to have been made as of the time 
such exempt use begins.
    (ii) Illustrations. Examples of assets which are ``used (or held for 
use) directly in carrying out the foundation's exempt purpose'' include, 
but are not limited to, the following:
    (a) Administrative assets, such as office equipment and supplies 
which are used by employees or consultants of the foundation, to the 
extent such assets are devoted to and used directly in the 
administration of the foundation's charitable, educational or other 
similar exempt activities;
    (b) Real estate or the portion of a building used by the foundation 
directly in its charitable, educational, or other similar exempt 
activities;
    (c) Physical facilities used in such activities, such as paintings 
or other works of art owned by the foundation which are on public 
display, fixtures and equipment in classrooms, research facilities and 
related equipment which under the facts and circumstances serve a useful 
purpose in the conduct of such activities;
    (d) Any interest in a functionally related business (as defined in 
subdivision (iii) of this subparagraph) or in a program-related 
investment (as defined in section 4944(c));
    (e) The reasonable cash balances (as described in subdivision (iv) 
of this subparagraph) necessary to cover current administrative expenses 
and other normal and current disbursements directly connected with the 
foundation's charitable, educational, or other similar exempt 
activities; and
    (f) Any property leased by a foundation in carrying out its 
charitable, educational, or other similar exempt purpose at no cost (or 
at a nominal rent) to the lessee or for a program-related purpose 
(within the meaning of section 4944(c)), such as the leasing of 
renovated apartments to low-income tenants at a low rental as part of 
the lessor foundation's program for rehabilitating a blighted portion of 
a community. For treatment of the income derived from such use, see 
paragraph (d) (2) (viii) of this section.
    (iii) Functionally related business--(a) In general. The term 
``functionally related business'' means:
    (1) A trade or business which is not an unrelated trade or business 
(as defined in section 513), or
    (2) An activity which is carried on within a larger aggregate of 
similar activities or within a larger complex of other endeavors which 
is related (aside from the need of the organization for income or funds 
or the use it makes of the profits derived) to the charitable, 
educational, or other similar exempt purpose of the organization.
    (b) Examples. The provisions of this subdivision may be illustrated 
by the following examples:

    Example 1. X, a private foundation, maintains a community of 
historic value which is open to the general public. For the convenience 
of the public, X, through a wholly owned, separately incorporated, 
taxable entity, maintains a restaurant and hotel in such community. Such 
facilities are within the larger aggregate of activities which makes 
available for public enjoyment the various buildings of historic 
interest and which is related to X's exempt purpose. Thus, the operation 
of the restaurant and hotel under such circumstances constitutes a 
functionally related business.
    Example 2. Y, a private foundation, as part of its medical research 
program under section 501(c) (3), publishes a medical journal in 
carrying out its exempt purpose. Space in

[[Page 78]]

the journal is sold for commercial advertising. Notwithstanding the fact 
that the advertising activity may be subject to the tax imposed by 
section 511, such activity is within a larger complex of endeavors which 
makes available to the scientific community and the general public 
developments with respect to medical research and is therefore a 
functionally related business.

    (iv) Cash held for charitable, etc. activities. For purposes of 
subdivision (ii)(e) of this subparagraph, the reasonable cash balances 
which a private foundation needs to have on hand to cover expenses and 
disbursements described in such subdivision will generally be deemed to 
be an amount, computed on an annual basis, equal to one and one-half 
percent of the fair market value of all assets described in subparagraph 
(1)(i) of this paragraph, without regard to subdivision (ii)(e) of this 
subparagraph. However, if the Commissioner is satisfied that under the 
facts and circumstances an amount in addition to such one and one-half 
percent is necessary for payment of such expenses and disbursements, 
then such additional amount may also be excluded from the amount of 
assets described in subparagraph (1)(i) of this paragraph. All remaining 
cash balances, including amounts necessary to pay any tax imposed by 
section 511 or any section of chapter 42 of the Code except section 
4940, are to be included in the assets described in subparagraph (1)(i) 
of this paragraph.
    (4) Valuation of assets--(i) Certain securities. (a) For purposes of 
subparagraph (1)(i) of this paragraph, a private foundation may use any 
reasonable method to determine the fair market value on a monthly basis 
of securities for which market quotations are readily available, as long 
as such method is consistently used. For purposes of this subparagraph, 
market quotations are readily available if a security is:
    (1) Listed on the New York Stock Exchange, the American Stock 
Exchange, or any city or regional exchange in which quotations appear on 
a daily basis, including foreign securities listed on a recognized 
foreign national or regional exchange;
    (2) Regularly traded in the national or regional over-the-counter 
market, for which published quotations are available; or
    (3) Locally traded, for which quotations can readily be obtained 
from established brokerage firms.
    (b) For purposes of this subdivision, commonly accepted methods of 
valuation must be used in making an appraisal. Valuations made in 
accordance with the principles stated in the regulations under section 
2031 constitute acceptable methods of valuation. This paragraph 
(c)(4)(i)(b) applies only for taxable years beginning before January 1, 
1976. See section 4942(e)(2)(B) and paragraph (c)(4)(i)(c) of this 
section for special valuation rules that apply for subsequent taxable 
years.
    (c) For purposes of this subdivision (i) and with respect to taxable 
years beginning after December 31, 1975, if the private foundation can 
show that the value of securities determined on the basis of market 
quotations as provided by subdivision (i)(a) does not reflect the fair 
market value thereof because:
    (1) The securities constitute a block of securities so large in 
relation to the volume of actual sales on the existing market that it 
could not be liquidated in a reasonable time without depressing the 
market.
    (2) The securities are securities in a closely held corporation and 
sales are few or of a sporadic nature, and, or
    (3) The sale of the securities would result in a forced or distress 
sale because the securities could not be offered to the public for sale 
without first being registered under the Securities Act of 1933 or 
because of other factors,

then the price at which the securities could be sold as such outside the 
usual market, as through an underwriter, may be a more accurate 
indication of value than market quotations. On the other hand, if the 
securities to be valued represents a controlling interest, either actual 
or effective, in a going business, the price at which other lots change 
hands may have little relation to the true value of the securities. No 
decrease in the fair market value of any given class of securities 
determined on the basis of market quotations as provided by subdivision 
(i)(a) shall be allowed except as authorized by this subdivision, and no 
such decrease shall in the aggregate exceed 10 percent of the fair 
market value of

[[Page 79]]

such class of securities so determined on the basis of market quotations 
and without regard to this subdivision.
    (d) In the case of securities described in subdivision (i)(a) of 
this subparagraph, which are held in trust for, or on behalf of, a 
foundation by a bank or other financial institution which values such 
securities periodically by use of a computer, a foundation may determine 
the correct value of such securities by use of such computer pricing 
system, provided the Commissioner has accepted such computer pricing 
system as a valid method for valuing securities for Federal estate tax 
purposes.
    (e) This subdivision may be illustrated by the following examples:

    Example 1. U, a private foundation, owns 1,000 shares of the stock 
of M Corporation. M stock is regularly traded on the New York Stock 
Exchange. U consistently follows a practice of valuing its 1,000 shares 
of M stock on the last trading day of each month based upon the quoted 
closing price for M stock. U's method of valuing its M Corporation stock 
is permissible under the rules contained in subdivision (i)(a) of this 
subparagraph.
    Example 2. Assume the facts as stated in example (1), except that U 
consistently follows a practice of valuing its 1,000 shares of M stock 
by taking the mean of the closing prices for M stock on the first and 
last trading days of each month and the trading day nearest the 15th day 
of each month. U's method of valuing its M stock is permissible under 
the rules contained in subdivision (i)(a) of this subparagraph.
    Example 3. Assume the facts as stated in example (1), except that U 
consistently follows a practice of valuing its M stock by taking the 
mean of the highest and lowest quoted prices for the stock on the last 
trading day of each month. U's method of valuing its M stock is 
permissible under the rules contained in subdivision (1)(a) of this 
subparagraph.
    Example 4. V, a private foundation, owns 1,000 shares of the stock 
of N Corporation. N stock is regularly traded in the national over-the-
counter market and published quotations of the bid and asked prices for 
the stock are available. V consistently follows a practice of valuing 
its 1,000 shares of N stock on the first trading day of each month by 
taking the mean of the bid and asked prices on that day. V's method of 
valuing its N Corporation stock is permissible under the rules contained 
in subdivision (i)(a) of this subparagraph.
    Example 5. W, a private foundation, owns 1,000 shares of the stock 
of O Corporation. O stock is locally traded and quotations can readily 
be obtained from established brokerage firms. W consistently follows a 
practice of valuing its O stock on the 15th day of each month by 
obtaining a bona fide quotation of bid and asked prices for the stock 
from an established brokerage firm and taking the mean of such prices on 
that day. If a quotation is unavailable on the regular valuation date, W 
values its O stock based upon a bona fide quotation on the first day 
thereafter on which such a quotation is available. W's method of valuing 
its O Corporation stock is permissible under the rules contained in 
subdivision (i)(a) of this subparagraph.

    (ii) Cash. In order to determine the amount of a foundation's cash 
balances, the foundation shall value its cash on a monthly basis by 
averaging the amount of cash on hand as of the first day of each month 
and as of the last day of each month.
    (iii) Common trust funds. If a private foundation owns a 
participating interest in a common trust fund (as defined in section 
584) established and administered under a plan providing for the 
periodic valuation of participating interests during the fund's taxable 
year and the reporting of such valuations to participants, the value of 
the foundation's interest in the common trust fund based upon the 
average of the valuations reported to the foundation during its taxable 
year will ordinarily constitute an acceptable method of valuation.
    (iv) Other assets. (a) Except as otherwise provided in subdivision 
(iv)(b) of this subparagraph, the fair market value of assets other than 
those described in subdivisions (i) through (iii) of this subparagraph 
shall be determined annually. Thus, the fair market value of securities 
other than those described in subdivision (i) of this subparagraph shall 
be determined in accordance with this subdivision (a). If, however, a 
private foundation owns voting stock of an issuer of unlisted securities 
and has, or together with disqualified persons or another private 
foundation has, effective control of the issuer (within the meaning of 
Sec. 53.4943-3(b)(3)(ii), then to the extent that the issuer's assets 
consist of shares of listed securities issues, such assets shall be 
valued monthly on the basis of market quotations or in accordance with 
section 4942(e)(2)(B), if applicable.

[[Page 80]]

Thus, for example, if a private foundation and a disqualified person 
together own all of the unlisted voting stock of a holding company which 
in turn holds a portfolio of securities of issues which are listed on 
the New York Stock Exchange, in determining the net worth of the holding 
company, the underlying portfolio securities are to be valued monthly by 
reference to market quotations for their issues unless a decrease in 
such value is authorized in accordance with section 4942(e)(2)(b). Such 
determination may be made by employees of the private foundation or by 
any other person, without regard to whether such person is a 
disqualified person with respect to the foundation. A valuation made 
pursuant to the provisions of this subdivision, if accepted by the 
Commissioner, shall be valid only for the taxable year for which it is 
made. A new valuation made in accordance with these provisions is 
required for the succeeding taxable year.
    (b) If the requirements of this subdivision are met, the fair market 
value of any interest in real property, including any improvements 
thereon, may be determined on a 5-year basis. Such value must be 
determined by means of a certified, independent appraisal made in 
writing by a qualified person who is neither a disqualified person with 
respect to, nor an employee of, the private foundation. The appraisal is 
certified only if it contains a statement at the end thereof to the 
effect that, in the opinion of the appraiser, the values placed on the 
assets appraised were determined in accordance with valuation principles 
regularly employed in making appraisals of such property using all 
reasonable valuation methods. The foundation shall retain a copy of the 
independent appraisal for its records. If a valuation made pursuant to 
the provisions of this subdivision in fact falls within the range of 
reasonable values for the appraised property, such valuation may be used 
by the foundation for the taxable year for which the valuation is made 
and for each of the succeeding 4 taxable years. Any valuation made 
pursuant to the provisions of this subdivision may be replaced during 
the 5-year period by a subsequent 5-year valuation made in accordance 
with the rules set forth in this subdivision, or with an annual 
valuation made in accordance with subdivision (iv)(a) of this 
subparagraph, and the most recent such valuation of such assets shall be 
used in computing the foundation's minimum investment return. In the 
case of a foundation organized before May 27, 1969, a valuation made in 
accordance with this subdivision applicable to the foundation's first 
taxable year beginning after December 31, 1972, and the 4 succeeding 
taxable years must be made no later than the last day of such first 
taxable year. In the case of a foundation organized after May 26, 1969, 
a valuation made in accordance with this subdivision applicable to the 
foundation's first taxable year beginning after February 5, 1973 and the 
succeeding 4 taxable years must be made no later than the last day of 
such first taxable year. Any subsequent valuation made in accordance 
with this subdivision must be made no later than the last day of the 
first taxable year for which such new valuation is applicable. A 
valuation, if properly made in accordance with the rules set forth in 
this subdivision, will not be disturbed by the Commissioner during the 
5-year period for which it applies even if the actual fair market value 
of such property changes during such period.
    (c) For purposes of this subdivision, commonly accepted methods of 
valuation must be used in making an appraisal. Valuations made in 
accordance with the principles stated in the regulations under section 
2031 constitute acceptable methods of valuation. The term appraisal, as 
used in this subdivision, means a determination of fair market value and 
is not to be construed in a technical sense peculiar to particular 
property or interests therein, such as, for example, mineral interests 
in real property.
    (v) Definition of ``securities''. For purposes of this subparagraph, 
the term ``securities'' includes, but is not limited to, common and 
preferred stocks, bonds, and mutual fund shares.
    (vi) Valuation date. (a) In the case of an asset which is required 
to be valued on an annual basis as provided in subdivision (iv)(a) of 
this subparagraph, such asset may be valued as of any day in the private 
foundation's taxable

[[Page 81]]

year to which such valuation applies, provided the foundation follows a 
consistent practice of valuing such asset as of such date in all taxable 
years.
    (b) A valuation described in subdivision (iv)(b) of this 
subparagraph may be made as of any day in the first taxable year of the 
private foundation to which such valuation is to be applied.
    (vii) Assets held for less than a taxable year. For purposes of this 
paragraph, any asset described in subparagraph (1)(i) of this paragraph 
which is held by a foundation for only part of a taxable year shall be 
taken into account for purposes of determining the foundation's minimum 
investment return for such taxable year by multiplying the fair market 
value of such asset (as determined pursuant to this subparagraph) by a 
fraction, the numerator of which is the number of days in such taxable 
year that the foundation held such asset and the denominator of which is 
the number of days in such taxable year.
    (5) Applicable percentage--(i) In general. For purposes of paragraph 
(c)(1)(ii) of this section, except as provided in paragraph (c)(5)(ii) 
or (iii) of this section, the applicable percentage is:
    (a) Six percent for a taxable year beginning in 1970 or 1971;
    (b) Five and a half percent for a taxable year beginning in 1972;
    (c) Five and one-quarter percent for a taxable year beginning in 
1973;
    (d) Six percent for a taxable year beginning in 1974 or 1975; and
    (e) Five percent for taxable years beginning after Dec. 31, 1975.
    (ii) Transitional rule. In the case of organizations organized 
before May 27, 1969 (including organizations deemed to be so organized 
by virtue of the provisions of paragraph (e)(2) of this section), 
section 4942 shall, for all purposes other than the determination of the 
minimum investment return under section 4942(j)(3)(B)(ii), for taxable 
years:
    (a) Beginning before January 1, 1972, apply without regard to 
section 4942(e).
    (b) Beginning in 1972, apply with an applicable percentage of 4\1/8\ 
percent,
    (c) Beginning in 1973, apply with an applicable percentage of 4\3/8\ 
percent and
    (d) Beginning in 1974, apply with an applicable percentage of 5\1/2\ 
percent.
    (iii) Short taxable periods. In any case in which a taxable year 
referred to in this subparagraph is a period less than 12 months, the 
applicable percentage to be applied to the amount determined under the 
provisions of subparagraph (1) of this paragraph shall be equal to the 
applicable percentage for the calendar year in which the short taxable 
period began multiplied by a fraction, the numerator of which is the 
number of days in such short taxable period and the denominator of which 
is 365.
    (d) Adjusted net income--(1) Definition. For purposes of paragraph 
(b) of this section, the term ``adjusted net income'' means the excess 
(if any) of:
    (i) The gross income for the taxable year (including gross income 
from any unrelated trade or business) determined with the income 
modifications provided by subparagraph (2) of this paragraph, over
    (ii) The sum of the deductions (including deductions directly 
connected with the carrying on of any unrelated trade or business), 
determined with the deduction modifications provided by subparagraph (4) 
of this paragraph, which would be allowed to a corporation subject to 
the tax imposed by section 11 for the taxable year.

In computing the income includible under this paragraph as gross income 
and the deductions allowable under this paragraph from such income, the 
principles of subtitle A of the Code shall apply except to the extent 
such principles conflict with section 4942 and the regulations 
thereunder (without regard to this sentence). Except as otherwise 
provided in this paragraph, no exclusions or deductions from gross 
income or credits against tax are allowable under this paragraph. For 
purposes of subdivision (i) of this subparagraph, the term ``gross 
income'' does not include gifts, grants, or contributions received by 
the private foundation but does include income from a functionally 
related business (as defined in paragraph (c)(3)(iii) of this section).
    (2) Income modifications. The income modifications referred to in 
subparagraph (1)(i) of this paragraph are as follows:

[[Page 82]]

    (i) Section 103 (relating to interest on certain governmental 
obligations) shall not apply. Hence, interest which would have been 
excluded from gross income by section 103 shall be included in gross 
income.
    (ii) Capital gains and losses from the sale or other disposition of 
property shall be taken into account only in an amount equal to any net 
short-term capital gain (as defined in section 1222(5)) for the taxable 
year. Long-term capital gain or loss is not included in the computation 
of adjusted net income. Similarly, net section 1231 gains shall be 
excluded from the computation of adjusted net income. However, net 
section 1231 losses shall be included in the computation of adjusted net 
income, if such losses are otherwise described in subparagraph (1)(ii) 
of this paragraph. Any net short-term capital loss for a given taxable 
year shall not be taken into account in computing adjusted net income 
for such year or in computing net short-term capital gain for purposes 
of determining adjusted net income for prior or future taxable years 
regardless of whether the foundation is a corporation or a trust.
    (iii) The following amounts shall be included in gross income for 
the taxable year:
    (a) Amounts received or accrued as repayments of amounts which were 
taken into account as a qualifying distribution within the meaning of 
paragraph (a)(2)(i) of Sec. 53.4942(a)-3 for any taxable year;
    (b) Notwithstanding subdivision (ii) of this subparagraph, gross 
amounts received or accrued from the sale or other disposition of 
property to the extent that the acquisition of such property was taken 
into account as a qualifying distribution (within the meaning of 
paragraph (a)(2)(ii) of Sec. 53.4942(a)-3) for any taxable year; and
    (c) Any amount set aside under paragraph (b) of Sec. 53.4942(a)-3 
to the extent it is determined that such amount is not necessary for the 
purposes for which it was set aside.
    (iv) Any distribution received by a private foundation from a 
disqualified person in redemption of stock held by such private 
foundation in a business enterprise shall be treated as not essentially 
equivalent to a dividend under section 302(b)(1) if all of the following 
conditions are satisfied:
    (a) Such redemption is of stock which was owned by a private 
foundation on May 26, 1969 (or which is acquired by a private foundation 
under the terms of a trust which was irrevocable on May 26, 1969, or 
under the terms of a will executed on or before such date which are in 
effect on such date and at all times thereafter);
    (b) Such foundation is required to dispose of such property in order 
not to be liable for tax under section 4943 (relating to taxes on excess 
business holdings) applied, in the case of a disposition before January 
1, 1975, without taking section 4943(c)(4) into account; and
    (c) Such foundation receives in return an amount which equals or 
exceeds the fair market value of such property at the time of such 
disposition or at the time a contract for such disposition was 
previously executed in a transaction which would not constitute a 
prohibited transaction (within the meaning of section 503(b) or the 
corresponding provisions of prior law).
    (v) If, as of the date of distribution of property for purposes 
described in section 170(c) (1) or (2)(B), the fair market value of such 
property exceeds its adjusted basis, such excess shall not be deemed an 
amount includible in gross income.
    (vi) The income received by a private foundation from an estate 
during the period of administration of such estate shall not be included 
in such foundation's gross income, unless, due to a prolonged period of 
administration, such estate is considered terminated for Federal income 
tax purposes by operation of paragraph (a) of Sec. 1.641(b)-3 of this 
chapter (Income Tax Regulations).
    (vii) Distributions received by a private foundation from a trust 
created and funded by another person shall not be included in the 
foundation's gross income. However, with respect to distributions from 
certain trusts described in section 4947(a)(2), see paragraph (b)(2) of 
this section.
    (viii) Gross income shall include all amounts derived from, or in 
connection with, property held by the foundation, even though the fair 
market value of such property may not be included in

[[Page 83]]

such foundation's assets for purposes of determining minimum investment 
return by operation of paragraph (c)(3) of this section.
    (ix) Gross income shall include amounts treated in a preceding 
taxable year as a ``qualifying distribution'' by operation of paragraph 
(c) of Sec. 53.4942(a)-3 where such amounts are not redistributed by 
the close of the donee organization's succeeding taxable year in 
accordance with the rules prescribed in such paragraph (c). In such 
cases, such amounts shall be included in the donor foundation's gross 
income for such foundation's first taxable year beginning after the 
close of the donee organization's first taxable year following the donee 
organization's taxable year of receipt.
    (x) For taxable years ending after October 4, 1976, section 
4942(f)(2)(D) states that section 483 (relating to imputed interest on 
deferred payments) does not apply to payments made pursuant to a binding 
contract entered into in a taxable year beginning before January 1, 
1970. Amounts that are not treated as imputed interest because of 
section 4942(f)(2)(D) and this subdivision will represent gain or loss 
from the sale of property. If the gain or loss is long term capital gain 
or loss, section 4942(f)(2)(B) excludes the gain or loss from the 
computation of the foundation's gross income. If, in a taxable year 
beginning after December 31, 1969, there is a substantial change in the 
terms of a contract entered into in a taxable year beginning before 
January 1, 1970, then any payment made pursuant to the changed contract 
is not considered a payment made pursuant to a contract entered into in 
a taxable year beginning before January 1, 1970. Whether or not a change 
in the terms of a contract (for example, a change relating to time of 
payment, sales price, or obligations under the contract) is a 
substantial change is determined by applying the rules under section 483 
and Sec. 1.483-1(b)(4). As used in this subdivision, a binding contract 
includes an irrevocable written option.
    (3) Adjusted basis--(i) In general. For purposes of subparagraph 
(2)(ii) of this paragraph, the adjusted basis for purposes of 
determining gain from the sale or other disposition of property shall be 
determined in accordance with the rules set forth in subdivision (ii) of 
this subparagraph and the adjusted basis for purposes of determining 
loss from such disposition shall be determined in accordance with the 
rules set forth in subdivision (iii) of this subparagraph. Further, the 
provisions of this subparagraph do not apply for any purpose other than 
for purposes of subparagraph (2)(ii) of this paragraph. For example, the 
determination of gain pursuant to the provisions of section 341 is 
determined without regard to this subparagraph.
    (ii) Gain from sale or other disposition. The adjusted basis for 
purposes of determining gain from the sale or other disposition of 
property shall be the greater of:
    (a) The fair market value of such property on December 31, 1969, 
plus or minus all adjustments after December 31, 1969, and before the 
date of sale or other disposition under the rules of Part II, Subchapter 
O, Chapter 1 of the Code, provided that the property was held by the 
private foundation on December 31, 1969, and continuously thereafter to 
such date of sale or other disposition; or
    (b) The adjusted basis as determined under the rules of Part II, 
Subchapter O, Chapter 1 of the Code, subject to the provisions of 
section 4940(c)(3)(B) and the regulations thereunder (and without regard 
to section 362(c)). With respect to assets acquired prior to December 
31, 1969, which were subject to depreciation or depletion, for purposes 
of determining the adjustments to be made to basis between the date of 
acquisition and December 31, 1969, and amount equal to straight-line 
depreciation or cost depletion shall be taken into account. In addition, 
in determining such adjustments to basis, if any other adjustments would 
have been made during such period (such as a change in useful life based 
upon additional data or a change in facts), such adjustments shall also 
be taken into account.
    (iii) Loss from sale or other disposition. For purposes of 
determining loss from the sale or other disposition of property, 
adjusted basis as determined in subdivision (ii)(b) of this subparagraph 
shall apply.

[[Page 84]]

    (iv) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A private foundation, which uses the cash receipts and 
disbursements method of accounting, purchased certain depreciable real 
property on December 1, 1969. On December 31, 1969, the fair market 
value of such property was $100,000 and its adjusted basis (determined 
under the provisions of this subparagraph) was $102,000. The property 
was sold on January 2, 1970, for $105,000. Because fair market value on 
December 31, 1969, $100,000, is less than the adjusted basis as 
determined by Part II, Subchapter O, Chapter 1 of the Code, $102,000, a 
short-term gain of $3,000 is recognized (i.e., sale price of $105,000 
less the greater of the two possible bases) for purposes of subparagraph 
(2)(ii) of this paragraph.
    Example 2. Assume the facts as stated in example (1), except that 
the sale price was $95,000. Because the sale price was $7,000 less than 
the adjusted basis for loss ($102,000 as determined by the application 
of subdivision (iii) of this subparagraph), there is a capital loss of 
$7,000 which may be deducted against short-term capital gains for 1970 
(if any) in determining net short-term capital gain.
    Example 3. A private foundation, which uses the cash receipts and 
disbursements method of accounting, purchased unimproved land on 
December 1, 1969. On December 31, 1969, the fair market value of such 
property was $110,000 and its adjusted basis (determined under the 
provisions of this subparagraph) was $102,000. The property was sold on 
January 2, 1970, for $105,000. Since the fair market value on December 
31, 1969, $110,000, exceeds the adjusted basis as determined by Part II, 
Subchapter O, Chapter 1 of the Code, $102,000, such fair market value 
will be used for purposes of determining gain. However, because the 
adjusted basis for purposes of determining gain exceeds the sale price, 
there is no gain. Furthermore, because the adjusted basis for purposes 
of determining loss, $102,000, is less than sale price, there is no 
loss.

    (4) Deduction modifications--(i) In general. For purposes of 
computing adjusted net income under subparagraph (1) of this paragraph, 
no deduction shall be allowed other than all the ordinary and necessary 
expenses paid or incurred for the production or collection of gross 
income or for the management, conservation, or maintenance of property 
held for the production of such income, except as provided in 
subdivision (ii) of this subparagraph. Such expenses include that 
portion of a private foundation's operating expenses which is paid or 
incurred for the production or collection of gross income. Operating 
expenses include compensation of officers, other salaries and wages of 
employees, interest, rent, and taxes. Where only a portion of the 
property produces (or is held for the production of) income subject to 
the provisions of section 4942, and the remainder of the property is 
used for charitable, educational, or other similar exempt purposes, the 
deductions allowed by this subparagraph shall be apportioned between the 
exempt and nonexempt uses. Similarly, where the deductions with respect 
to property used for a charitable, educational, or other similar exempt 
purpose exceed the income derived from such property, such excess shall 
not be allowed as a deduction, but may be treated as a qualifying 
distribution described in paragraph (a)(2)(ii) of Sec. 53.4942(a)-3. 
Furthermore, this subdivision does not allow deductions which are not 
paid or incurred for the purposes herein prescribed. Thus, for example, 
the deductions prescribed by the following sections are not allowable: 
(a) The charitable contributions deduction prescribed under sections 170 
and 642(c); (b) the net operating loss deduction prescribed under 
section 172; and (c) the special deductions prescribed under Part VIII, 
Subchapter B, Chapter 1 of the Code.
    (ii) Special rules. For purposes of computing adjusted net income 
under subparagraph (1) of this paragraph: (a) The allowances for 
depreciation and depletion as determined under section 4940(c)(3)(B) and 
the regulations thereunder shall be taken into account, and (b) section 
265 (relating to expenses and interest relating to tax-exempt interest) 
shall not apply.
    (e) Certain transitional rules--(1) In general. In the case of 
organizations organized before May 27, 1969, section 4942 shall:
    (i) Not apply to an organization to the extent its income is 
required to be accumulated pursuant to the mandatory terms (as in effect 
on May 26, 1969, and at all times thereafter) of an instrument executed 
before May 27, 1969, with respect to the transfer of income producing 
property to such organization, except that section 4942 shall

[[Page 85]]

apply to such organization if the organization would have been denied 
exemption had section 504(a) not been repealed, or would have had its 
deductions under section 642(c) limited had section 681(c) not been 
repealed. In applying the preceding sentence, in addition to the 
limitations contained in section 504(a) or 681(c) before its repeal, 
section 504(a)(1) or 681(c)(1) shall be treated as not applying to an 
organization to the extent its income is required to be accumulated 
pursuant to the mandatory terms (as in effect on January 1, 1951, and at 
all times thereafter) of an instrument executed before January 1, 1951, 
with respect to the transfer of income producing property to such 
organization before such date, if such transfer was irrevocable on such 
date; and
    (ii) Not apply to an organization which is prohibited by its 
governing instrument or other instrument from distributing capital or 
corpus to the extent the requirements of section 4942 are inconsistent 
with such prohibitions.
    (2) Certain existing organizations. For purposes of this section, an 
organization will be deemed to be organized prior to May 26, 1969, if it 
is either a testamentary trust created under the will of an individual 
who died prior to such date or an inter visos trust which was in 
existence and irrevocable prior to such date, even though it is not 
funded until after May 26, 1969. Similarly, a split-interest trust, as 
described in section 4947(a)(2) (without regard to section 
4947(a)(2)(C)), which became irrevocable prior to May 27, 1969, and 
which is treated as a private foundation under section 4947(a)(1) 
subsequent to such date, likewise shall be treated as an organization 
organized prior to such date. See section 507(b)(2) and the regulations 
thereunder with respect to the applicability of transitional rules where 
there has been a merger of two or more private foundations or a 
reorganization of a private foundation.
    (3) Limitation. With respect to taxable years beginning after 
December 31, 1971, subparagraph (1) (i) and (ii) of this paragraph shall 
apply only for taxable years during which there is pending any judicial 
proceeding by the private foundation which is necessary to reform, or to 
excuse such foundation from compliance with, its governing instrument or 
any other instrument (as in effect on May 26, 1969) in order to comply 
with the provisions of section 4942, and in the case of subparagraph 
(1)(i) of this paragraph for all taxable years following the taxable 
year in which such judicial proceeding is terminated during which the 
governing instrument or any other instrument does not permit compliance 
with such provisions. Thus, the exception described in subparagraph 
(1)(ii) of this paragraph applies after 1971 only for taxable years 
during which such judicial proceeding is pending. Accordingly, beginning 
with the first taxable year following the taxable year in which such 
judicial proceeding is terminated, such foundation will be required to 
meet the requirements of section 4942 and the regulations thereunder 
(and be subject to the taxes provided upon failure to do so) except to 
the extent such foundation is required to accumulate income as described 
in subparagraph (1)(i) of this paragraph, even if the governing 
instrument continues to prohibit invasion of capital or corpus. In any 
case where a foundation's governing instrument or any other instrument 
requires accumulation of income as described in subparagraph (1)(i) of 
this paragraph beginning with the first taxable year following the 
taxable year in which such judicial proceeding is terminated, the 
distributable amount (as defined in paragraph (b) of this section) for 
such foundation shall be reduced by the amount of the income required to 
be accumulated. Therefore, if the foundation's adjusted net income for 
any taxable year equals or exceeds its minimum investment return for 
such year, the accumulation provisions will be given full effect. 
However, if the minimum investment return exceeds the adjusted net 
income for any taxable year, the foundation will be required to 
distribute such excess for such year. For purposes of this paragraph, a 
judicial proceeding will be treated as pending only if the foundation is 
diligently pursuing its judicial remedies and there is no unreasonable 
delay in such proceeding for which the private foundation is 
responsible.

[[Page 86]]

    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. X, a private foundation organized in 1930, is required by 
the mandatory terms of its governing instrument to accumulated 25 
percent of its adjusted net income and to add such accumulations to 
corpus. The instrument also prohibits distribution of corpus for any 
purpose. On July 13, 1971, X instituted an action in the appropriate 
State court to reform the instrument by deleting the accumulation and 
corpus provisions described above. If the court's final order reforms 
the accumulation provisions to allow distributions of income sufficient 
to avoid the imposition of a tax under section 4942, then section 4942 
applies to X, regardless of the court's action with respect to the 
corpus provisions. However, if the court rules that the accumulation 
provision may not be reformed, section 4942 applies to X only to the 
extent provided for in subparagraph (3) of this paragraph, regardless of 
the court's action with respect to the corpus provision.
    Example 2. Private foundation Y was created by the will of A who 
died in 1940. Y's governing instrument requires that 40 percent of Y's 
adjusted net income be added to corpus each year. In an action commenced 
prior to December 31, 1971, a court of competent jurisdiction rules that 
this accumulation provisions must be complied with. In Y's succeeding 
taxable year its adjusted net income is $120,000, and its minimum 
investment return is $140,000. Thus, Y is required to accumulated 
$48,000 (40 percent of $120,000) and shall be allowed to do so. 
Therefore, Y's distributable amount for such taxable year shall be the 
greater of its adjusted net income ($120,000) or its minimum investment 
return ($140,000), reduced by the amount of the income required to be 
accumulated ($48,000) and the taxes imposed by Subtitle A of the Code 
and section 4940 and increased by any trust distributions described in 
paragraph (b)(2) of this section. Accordingly, Y's distributable amount 
for such taxable year is $92,000 ($140,000 reduced by $48,000), before 
other adjustments. If Y's minimum investment return had been $120,000 
instead of $140,000, its distributable amount for such taxable year 
would have been $72,000 ($120,000 reduced by $48,000), before other 
adjustments. Similarly, if Y's minimum investment return had been 
$100,000 instead of $140,000, its distributable amount for such taxable 
year would also have been $72,000, before other adjustments.

[T.D. 7256, 38 FR 3317, Feb. 5, 1973; 38 FR 4577, Feb. 16, 1973, as 
amended by T.D. 7486, 42 FR 24265, May 13, 1977; TD 7594, 44 FR 7138, 
Feb. 6, 1979; T.D. 7610, 44 FR 21644, Apr. 11, 1979; T.D. 7715, 45 FR 
56803, Aug. 26, 1980; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7878, 
48 FR 11943, Mar. 22, 1983]



Sec. 53.4942(a)-3  Qualifying distributions defined.

    (a) In general--(1) Distributions generally. For purposes of section 
4942 and the regulations thereunder, the amount of a qualifying 
distribution of property (as defined in subparagraph (2) of this 
paragraph) is the fair market value of such property as of the date such 
qualifying distribution is made. The amount of an organization's 
qualifying distributions will be determined solely on the cash receipts 
and disbursements method of accounting described in section 446(c)(1).
    (2) Definition. The term qualifying distribution means:
    (i) 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, or
    (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;
    (ii) Any amount paid to acquire an asset used (or held for use) 
directly in carrying out one or more purposes described in section 
170(c) (1) or (2)(B). See paragraph (c)(3) of Sec. 53.4942(a)-2 for the 
definition of used (or held for use); or
    (iii) Any amount set aside within the meaning of paragraph (b) of 
this section.
    (3) Control. 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

[[Page 87]]

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. ``Control'' 
of a donee organization is determined without regard to any conditions 
imposed upon the donee as part of the distribution or any other 
restrictions accompanying the distribution as to the manner in which the 
distribution is to be used, unless such conditions or restrictions are 
described in paragraph (a)(8) of Sec. 1.507-2 of this chapter (Income 
Tax Regulations). In general, it is the donee, not the distribution, 
which must be ``controlled'' by the distributing private foundation for 
the provisions of subparagraph (2)(i)(b) of this paragraph to apply. 
Thus, the furnishing of support to an organization and the consequent 
imposition of budgetary procedures upon that organization with respect 
to such support shall not in itself be treated as subjecting that 
organization to the distributing foundation's control within the meaning 
of this subparagraph. Such ``budgetary procedures'' include expenditure 
responsibility requirements under section 4945(d)(4). 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.
    (4) Borrowed funds--(i) In general. For purposes of this paragraph, 
if a private foundation borrows money in a particular taxable year to 
make expenditures for a specific charitable educational, or other 
similar purpose, a qualifying distribution out of such borrowed funds 
will, except as otherwise provided in subdivision (ii) of this 
subparagraph, be deemed to have been made only at the time that such 
borrowed funds are actually distributed for such exempt purpose.
    (ii) Funds borrowed before 1970. (a) If a private foundation has 
borrowed money in a taxable year beginning before January 1, 1970, or 
subsequently borrows money pursuant to a written commitment which was 
binding as of the last day of such taxable year, to make expenditures 
for a specific charitable, educational, or other similar exempt purpose, 
if such borrowed funds are in fact expended for such purpose in any 
taxable year, and if such loan is thereafter repaid, in whole or in 
part, in a taxable year beginning after December 31, 1969, then, at the 
election of the foundation as provided in subdivision (ii)(b) of this 
subparagraph, a qualifying distribution will be deemed to have been made 
at such time or times that such loan principal is so repaid rather than 
at the earlier time that the borrowed funds were actually distributed 
for such exempt purpose.
    (b) The election described in subdivision (ii)(a) of this 
subparagraph is to be made by attaching a statement to the form the 
private foundation is required to file under section 6033 for the first 
taxable year beginning after December 31, 1969, in which a repayment of 
loan principal is made. Such statement shall be made a part of such form 
and shall be attached to such form in each succeeding taxable year in 
which any repayment of loan principal is made. The statement shall set 
forth the name and address of the lender, the amount borrowed, the 
specific use made of such borrowed funds, and the private foundation's 
election to treat repayments of loan principal as qualifying 
distributions.
    (iii) Interest. Any payment of interest with respect to a loan 
described in subdivision (i) or (ii) of this subparagraph shall be 
treated as a deduction under paragraph (d)(1)(ii) of Sec. 53.4942(a)-2 
in the taxable year in which it is made.
    (5) Changes in use of an asset. If an asset not used (or held for 
use) directly in carrying out one or more purposes described in section 
170(c) (1) or (2)(B) is subsequently converted to such a use, the 
foundation may treat such conversion as a qualifying distribution. The 
amount of such qualifying distribution shall be the fair market value of 
the converted asset as of the date of its conversion. For purposes of 
the preceding sentence, fair market value shall be determined by making 
a valuation of the converted asset as of the date of its conversion in 
accordance with the rules set forth in paragraph (c)(4) of Sec. 
53.4942(a)-2.

[[Page 88]]

    (6) Certain foreign organizations--(i) In general. Distributions for 
purposes described in section 170(c)(2)(B) to a foreign organization, 
which has not received a ruling or determination letter that it is an 
organization described in section 509(a) (1), (2), or (3) or 4942(j)(3), 
will be treated as a distribution made to an organization described in 
section 509(a) (1), (2), or (3) or 4942(j)(3) if the distributing 
foundation has made a good faith determination that the donee 
organization is an organization described in section 509(a) (1), (2), or 
(3) or 4942(j)(3). Such a ``good faith determination'' ordinarily will 
be considered as made where the determination is based on an affidavit 
of the donee organization or an opinion of counsel (of the distributing 
foundation or the donee organization) that the donee is an organization 
described in section 509(a) (1), (2), or (3) or 4942(j)(3). Such an 
affidavit or opinion must set forth sufficient facts concerning the 
operations and support of the donee organization for the Internal 
Revenue Service to determine that the donee organization would be likely 
to qualify as an organization described in section 509(a) (1), (2), or 
(3) or 4942(j)(3).
    (ii) Definition. For purposes of this subparagraph, the term foreign 
organization means any organization which is not described in section 
170(c)(2)(A).
    (7) Payment of tax. The payment of any tax imposed under chapter 42 
of the Code shall not be treated as a qualifying distribution.
    (8) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which uses the calendar year as 
the taxable year, makes the following payments in 1970: (i) a payment of 
$44,000 to five employees for conducting a foundation program of 
educational grants for research and study; (ii) $20,000 for various 
items of overhead, 10 percent of which is attributable to the activities 
of the employees mentioned in payment (i) of this example and the other 
90 percent of which is attributable to administrative expenses which 
were not paid to accomplish any section 170(c) (1) or (2)(B) purpose; 
and (iii) a $100,000 general purpose grant paid to an educational 
institution described in section 170(b)(1)(A)(ii) which is not 
controlled by M or any disqualified persons with respect to M. Payments 
(i) and (ii) of this example are qualifying distributions to the extent 
of $46,000 ($44,000 of salaries and 10 percent of the overhead, both of 
which are reasonable administrative expenses paid to accomplish section 
170(c) (1) or (2)(B) purposes). Payment (iii) of this example is also a 
qualifying distribution, since it is a contribution for section 
170(c)(2)(B) purposes to an organization which is not described in 
subparagraph (2)(i) (a) or (b) of this paragraph. The other 90 percent 
of payment (ii) of this example may constitute items of deduction under 
paragraph (d)(1)(ii) of Sec. 53.4942(a)-2 if such items otherwise 
qualify under such paragraph.
    Example 2. On February 21, 1972, N, a private foundation which uses 
the calendar year as the taxable year, pays $500,000 for real property 
on which it plans to build hospital facilities to be used for medical 
care and education. The real property produces no income and the 
hospital facilities will not be constructed until 1974 according to the 
setaside plan submitted to and approved by the Commissioner pursuant to 
paragraph (b) of this section. The purchase of the land is a qualifying 
distribution under subparagraph (2)(ii) of this paragraph. If, however, 
the property used were to produce rental income for more than a 
reasonable period of time before construction of the hospital is begun, 
then as of the time such rental use becomes unreasonable (i) such 
purchase would no longer constitute a qualifying distribution under 
subparagraph (2)(ii) of this paragraph, and (ii) the amount of the 
qualifying distribution would be included in N's gross income. See 
paragraphs (c)(3)(i) and (d)(2)(iii)(b) of Sec. 53.4942(a)-2.
    Example 3. In 1971, X, a private foundation engaged in holding 
paintings and exhibiting them to the public, purchases an additional 
building to be used to exhibit the paintings. Such expenditure is a 
qualifying distribution under subparagraph (2)(ii) of this paragraph. In 
1975, X sells the building. Under paragraph (d)(2)(iii)(b) of Sec. 
53.4942(a)-2, all of the proceeds of the sale (less direct costs of the 
sale) are included in X's adjusted net income for 1975.
    Example 4. In January 1969, M, a private foundation which uses the 
calendar year as the taxable year, borrows $10 million to give to N, a 
private college, for the construction of a science center. M borrowed 
the money from X, a commercial bank. M is to repay X at the rate of $1.1 
million per year ($1 million principal and $0.1 million interest) for 10 
years, beginning in January, 1973. M distributed $5 million of the 
borrowed funds to N in February 1969 and the other $5 million in March 
1970. M files a statement with the form it is required to file under 
section 6033 for 1973 which contains the information required by 
subparagraph (4)(ii)(b) of this paragraph. Pursuant to M's election, 
each repayment of loan principal constitutes a qualifying distribution 
in the year of repayment. Accordingly, the distribution of $5 million to

[[Page 89]]

N in March 1970 will not be treated as a qualifying distribution. Each 
payment of interest ($0.1 million annually) with respect to M's loan 
from X is treated as a deduction under paragraph (d)(1)(ii) of Sec. 
53.4942(a)-2 in the taxable year in which it is made.
    Example 5. Private foundation Y engages in providing care for the 
aged. Y makes a distribution of cash to H, a hospital described in 
section 170(b)(1)(A)(iii) which is not controlled by Y or any 
disqualified person with respect to Y. The distribution is made subject 
to the conditions that H will invest the money as a separate fund which 
will bear a name commemorating the creator of Y and will use the income 
from such fund only for H's exempt hospital purposes which relate to 
care for the aged. Under these circumstances, the distribution from Y to 
H is a qualifying distribution pursuant to subparagraph (2)(i) of this 
paragraph.

    (b) Certain set-asides--(1) In general. An amount set aside for a 
specific project that is for one or more of the purposes described in 
section 170(c) (1) or (2)(B) may be treated as a qualifying distribution 
in the year in which set aside (but not in the year in which actually 
paid), if the requirements of section 4942(g)(2) and this paragraph (b) 
are satisfied. The requirements of this paragraph (b) are satisfied if 
the private foundation establishes to the satisfaction of the 
Commissioner that the amount set aside will be paid for the specific 
project within 60 months after it is set aside, and
    (i) The set-aside satisfies the suitability test described in 
subparagraph (2) of this paragraph, or
    (ii) With respect to a set-aside made in a taxable year beginning 
after December 31, 1974, the private foundation satisfies the cash 
distribution test described in subparagraph (3) of this paragraph.

If the suitability test or cash distribution test is otherwise 
satisfied, the 60 month period for paying the amount set aside may, for 
good cause shown, be extended by the Commissioner.
    (2) Suitability test. The suitability test is satisfied if the 
private foundation establishes to the satisfaction of the Commissioner 
that the specific project for which the amount is set aside is one that 
can be better accomplished by the set-aside than by the immediate 
payment of funds. Specific projects that can be better accomplished by 
the use of a set-aside include, but are not limited to, projects in 
which relatively long-term grants or expenditures must be made in order 
to assure the continuity of particular charitable projects or program-
related investments (as defined in section 4944(c)) or where grants are 
made as part of a matching-grant program. Such projects include, for 
example, a plan to erect a building to house the direct charitable, 
educational, or other similar exempt activity of the private foundation 
(such as a museum building in which paintings are to be hung), even 
though the exact location and architectural plans have not been 
finalized; a plan to purchase an additional group of paintings offered 
for sale only as a unit that requires an expenditure of more than one 
year's income; or a plan to fund a specific research program that is of 
such magnitude as to require an accumulation of funds before beginning 
the research, even though not all of the details of the program have 
been finalized.
    (3) Cash distribution test; in general. The cash distribution test 
is satisfied if:
    (i) The specific project for which the amount is set aside will not 
be completed before the end of the taxable year in which the set-aside 
is made,
    (ii) The private foundation actually distributes, in cash or its 
equivalent and for one or more of the purposes described in section 
170(c) (1) or (2)(B), the ``start-up period minimum amount'' described 
in subparagraph (4) of this paragraph during the private foundation's 
start-up period, and
    (iii) The private foundation actually distributes, in cash or its 
equivalent and for one or more of the purposes described in section 
170(c) (1) or (2)(B), the ``full-payment period minimum amount'' 
described in subparagraph (5) of this paragraph in each taxable year of 
the private foundation's full-payment period.

For purposes of the cash distribution test, an amount set aside will be 
treated as distributed in the year in which actually paid and not in the 
year in which set aside.
    (4) Minimum distribution required during start-up period--(i) Start-
up period. For private foundations created before January 1, 1972, the 
start-up period is

[[Page 90]]

the four taxable years immediately preceding the taxable year beginning 
in calendar year 1976. For private foundations created after December 
31, 1971 (or for organizations that first become private foundations 
after that date), the start-up period is the four taxable years 
following the taxable year in which the private foundation was created 
(or otherwise became a private foundation). For purposes of this 
subparagraph (4), a private foundation will be considered ``created'' in 
the taxable year in which the private foundation's distributable amount 
(as determined under section 4942(d)) first exceeds $500.
    (ii) Start-up period minimum amount. The amount that a private 
foundation must actually distribute in cash or its equivalent during the 
private foundation's start-up period is not less than the sum of:
    (a) Twenty percent of the private foundation's distributable amount 
(as determined under section 4942(d)) for the first taxable year of the 
start-up period,
    (b) Forty percent of the private foundation's distributable amount 
for the second taxable year of the start-up period,
    (c) Sixty percent of the private foundation's distributable amount 
for the third taxable year of the start-up period, and
    (d) Eighty percent of the private foundation's distributable amount 
for the fourth taxable year of the start-up period.
    (iii) Timing of distributions. The requirement that a private 
foundation distribute the start-up period minimum amount during the 
start-up period is a requirement that such amount be distributed before 
the end of the start-up period, and is not a requirement that any 
portion of such amount be distributed in any one taxable year of the 
start-up period.
    (iv) Distribution actually made during start-up period. In general, 
only a distribution actually made during the start-up period is taken 
into account in determining whether a private foundation has distributed 
the start-up period minimum amount. However, in the case of a private 
foundation created after December 31, 1971 (or an organization that 
first became a private foundation after that date), a distribution 
actually made during the taxable year in which the foundation was 
created (the year immediately preceding the first taxable year of the 
private foundation's start-up period) may be treated as a distribution 
actually made during the start-up period. In addition, a distribution 
actually made by a private foundation within 5\1/2\ months after the end 
of the start-up period will be treated as a distribution actually made 
during the start-up period if:
    (a) The private foundation was unable to determine the distributable 
amount for the fourth taxable year of the start-up period until after 
the end of such period, and
    (b) The private foundation actually made distributions prior to the 
end of the start-up period based upon a reasonable estimate of the 
private foundation's distributable amount for the fourth taxable year of 
the start-up period.
    (v) Examples. The provisions of this subparagraph (4) may be 
illustrated by the following examples:

    Example 1. F, a private foundation created on January 1, 1975, uses 
the calendar year as its taxable year. The start-up period for F is 
January 1, 1976 through December 31, 1979. F has distributable amounts 
under section 4942(d) for taxable years 1976 through 1979 in the 
following amounts: 1976, $100,000; 1977, $120,000; 1978, $150,000; 1979, 
$200,000. F's start-up period minimum amount is the sum of the following 
amounts: 20% of $100,000 ($20,000); 40% of $120,000 ($48,000); 60% of 
$150,000 ($90,000); and 80% of $200,000 ($160,000); which equals 
$318,000. Thus F is required to actually distribute at least $318,000 in 
cash or its equivalent during the start-up period.
    Example 2. F, a private foundation created in 1969, uses the 
calendar year as its taxable year. F's start-up period is the calendar 
years 1972 through 1975. F makes two cash distributions in 1972. The 
first distribution is made on account of a set-aside made in 1969. Under 
section 4942(g), that distribution is treated as a qualifying 
distribution made in 1969. The second distribution is treated under 
section 4942(h) has made out of F's undistributed income for 1971. In 
addition, F makes a cash distribution in 1976 that is treated under 
section 4942(h) as made out of F's undistributed income for 1975. In 
determining whether F has distributed its start-up period minimum amount 
within the start-up period, the 1972 distributions are both taken into 
account because they were actually made during F's start-up period. The 
1976 distribution is not taken into account, however, because

[[Page 91]]

that distribution was not actually made during F's start-up period.

    (5) Minimum distribution required during full-payment period--(i) 
Full-payment period. A private foundation's full-payment period includes 
each taxable year that begins after the end of the private foundation's 
start-up period.
    (ii) Full-payment period minimum amount. The amount that a private 
foundation must actually distribute in cash or its equivalent in a 
taxable year of the private foundation's full-payment period is not less 
than 100 percent of the private foundation's distributable amount 
determined under section 4942(d) (without regard to section 4942(i)) 
with respect to the taxable year.
    (iii) Carryover of distributions in excess of full-payment period 
minimum amount. If, in a taxable year beginning after December 31, 1975, 
a private foundation distributes an amount in excess of the full-payment 
period minimum amount for the taxable year, the excess shall be used to 
reduce the full-payment period minimum amount in the taxable years in 
the adjustment period. The amount of the excess distribution used to 
reduce the full-payment period minimum amount in each successive taxable 
year of the adjustment period shall be equal to the amount of such 
excess less the sum of the full-payment period minimum amounts for all 
prior taxable years in the adjustment period to which the excess was 
previously applied. The taxable years in the adjustment period are the 
five taxable years immediately following the taxable year in which the 
excess distribution is made. Any distribution in excess of the full-
payment period minimum amount made during a taxable year of the 
adjustment period shall not be taken into account under this 
subparagraph (iii) until any earlier excess has been completely applied 
against full-payment period minimum amounts during its adjustment 
period.
    (iv) Distributions actually made during a taxable year. Except as 
described in subdivision (ii) of subparagraph (6), only a distribution 
actually made during a taxable year of the full-payment period is taken 
into account in determining whether a private foundation has distributed 
the full-payment period minimum amount for such year.
    (v) Examples. The provisions of this subparagraph (5) may be 
illustrated by the following examples:

    Example 1. F, a private foundation created on January 1, 1973, uses 
the calendar year as its taxable year. F has a start-up period of 
January 1, 1974, through December 31, 1977, and a full-payment period 
that includes every taxable year beginning after December 31, 1977. F's 
distributable amount (as determined under section 4942(d)) for 1978 is 
$500,000. Thus, F's full-payment period minimum amount for 1978 is 
$500,000. During 1978 F distributes $100,000 in cash to Charity X and 
$400,000 in cash to Charity Y on account of a set-aside made in 1973. F 
has distributed its full-payment period minimum amount for 1978 because 
it has made actual cash distributions during that year which total 
$500,000. However, F has made qualifying distributions (as determined 
under section 4942(g)) with respect to 1978 of only $100,000. In order 
to avoid liability for the tax on undistributed income under section 
4942(a), F must distribute or set aside an additional $400,000 before 
January 1, 1980.
    Example 2. Assume the facts as stated in Example (1) except that in 
1978 F makes cash distributions totaling $600,000. Since the total cash 
distributions made in 1978 ($600,000) exceed the full-payment period 
minimum amount for 1978 ($500,000), there exists a $100,000 excess which 
must be used by F to reduce its full-payment period minimum amounts for 
the years 1979-1983 (the taxable years in the adjustment period with 
respect to the 1978 excess). Therefore, if F's distributable amount (as 
determined under section 4942(d)) for 1979 is $500,000, F's full-payment 
period minimum amount for 1979 is $400,000 ($500,000-$100,000).

    (6) Failure to distribute minimum amounts--(i) In general. If a 
private foundation fails to actually distribute the start-up period 
minimum amount during the start-up period or, except as described in 
subdivision (ii) of this subparagraph (6), if a private foundation fails 
to actually distribute the full-payment period minimum amount during a 
taxable year of the full-payment period, then any set-aside made by the 
private foundation during the start-up period (if the failure relates to 
the start-up period) or during the taxable year (if the failure relates 
to the full-payment period) that was not approved by the Commissioner 
under the suitability test described in subparagraph (2) of this 
paragraph will not be treated

[[Page 92]]

as a qualifying distribution. Further, any set-aside made after the year 
of such a failure to so distribute a minimum amount will be treated as a 
qualifying distribution only if the Commissioner approves the set-aside 
under the suitability test. In any case in which a set-aside ceases to 
be treated as a qualifying distribution as a result of a failure to 
distribute the full-payment period minimum amount, a private foundation 
may be assessed a deficiency under section 4942(a) within the period 
described in section 6501(n)(3).
    (ii) Correction of certain failures to distribute. If a private 
foundation's failure to distribute the full-payment period minimum 
amount during a taxable year of the full-payment period was not willful 
and was due to reasonable cause, the private foundation may correct the 
failure to so distribute. Correction will be achieved if the private 
foundation distributes within the correction period cash or its 
equivalent in an amount not less than the difference between the full-
payment period minimum amount for the taxable year and the amount 
actually distributed during the taxable year. The correction period is 
the correction period as defined in section 4962(e), determined with 
respect to the earliest occurring taxable event (as defined in section 
4962(e)(2)(A)) that would result if the failure to distribute a full-
payment period minimum amount were not corrected. The additional 
distribution will be treated for purposes of subparagraph (5) of this 
paragraph as made during the taxable year with respect to which the 
failure occurred. If a private foundation fails to distribute the full-
payment period minimum amount during a taxable year of the full-payment 
period because such amount can be determined only after the end of the 
taxable year, no ``willful failure to distribute'' the full-payment 
period minimum amount will occur if the private foundation makes an 
additional distribution within 5\1/2\ months after the end of the 
taxable year.
    (7) Approval and information requirements--(i) Suitability test. If 
an amount is set aside under the suitability test of section 
4942(g)(2)(B)(i) and subparagraph (2) of this paragraph, the private 
foundation must apply for the Commissioner's approval of the set-aside 
before the end of the taxable year in which the amount is set aside. The 
Commissioner will either approve or disapprove the set-aside in writing. 
An otherwise proper set-aside will not be treated as a qualifying 
distribution under this paragraph (b) with respect to a taxable year if 
the Commissioner's approval is not sought before the end of the taxable 
year in which the amount is actually set aside. To obtain approval by 
the Commissioner for a set-aside under the suitability test, the private 
foundation must write to Commissioner of Internal Revenue, Attention: 
OP:E:EO:T, 1111 Constitution Avenue, NW., Washington, DC 20224, and 
include:
    (a) A statement describing the nature and purposes of the specific 
project and the amount of the set-aside for which approval is requested;
    (b) A statement describing the amounts and approximate dates of any 
planned additions to the set-aside after its initial establishment;
    (c) A statement of the reasons why the project can be better 
accomplished by a set-aside than by the immediate payment of funds;
    (d) A detailed description of the project, including estimated 
costs, sources of any future funds expected to be used for completion of 
the project, and the location or locations (general or specific) of any 
physical facilities to be acquired or constructed as part of the 
project; and
    (e) A statement by an appropriate foundation manager (as defined in 
section 4946(b)) that the amounts to be set aside will actually be paid 
for the specific project within a specified period of time that ends not 
more than 60 months after the date of the first set-aside, or a 
statement showing good cause why the period for paying the amount set 
aside should be extended (including a showing that the proposed project 
could not be divided into two or more projects covering periods of no 
more than 60 months each) and setting forth the extension of time 
required.
    (ii) Cash distribution test. If an amount is set aside under the 
cash distribution test of section 4942(g)(2)(B)(ii) and subparagraphs 
(3), (4), and (5) of this paragraph, then for taxable years

[[Page 93]]

ending after April 2, 1984, the private foundation must submit an 
attachment with the return required by section 6033 for the taxable year 
in which the amount is set aside and for certain subsequent taxable 
years. For the taxable year in which the amount is set aside the 
attachment must include:
    (a) A statement describing the nature and purposes of the specific 
project for which amounts are to be set aside;
    (b) A statement that the amounts set aside for the specific project 
will actually be paid for the specific project within a specified period 
of time that ends not more than 60 months after the date of the set-
aside;
    (c) A statement that the project will not be completed before the 
end of the taxable year of the private foundation in which the set-aside 
is made;
    (d) A statement showing the distributable amounts determined under 
section 4942(d) for any past taxable years in the private foundation's 
start-up and full-payment periods; and
    (e) A statement showing the aggregate amount of actual payments made 
in cash or its equivalent, for purposes described in section 170(c) (1) 
or (2)(B), during each taxable year in the private foundation's start-up 
and full-payment periods. This statement should include a detailed 
description of any payments that are to be treated, pursuant to the 
rules of subparagraphs (4)(iv) and (6)(ii) of this paragraph (b), as 
distributed during a taxable year prior to the taxable year in which 
such payments were actually made and, in addition, should explain the 
circumstances that justify the application of those rules.

For the five taxable years following the taxable year in which the 
amount is set aside (or, if longer, for each taxable year in the 
extended period for paying the amount set aside), the attachment must 
include the statements required by (d) and (e) of this subdivision (ii). 
The submission of the statement required by (b) of this subdivision (ii) 
will satisfy the requirement of section 4942(g)(2)(B) and subparagraph 
(1) of this paragraph (b) that the private foundation establish to the 
satisfaction of the Commissioner that the amount set aside will be paid 
for the specific project within 60 months after it is set aside.
    (8) Evidence of set-aside. A set-aside that is approved by the 
Commissioner or which satisfies the cash distribution test shall be 
evidenced by the entry of a dollar amount on the books and records of a 
private foundation as a pledge or obligation to be paid at a future date 
or dates. Any amount which is set aside shall be taken into account for 
purposes of determining the private foundation's minimum investment 
return under Sec. 53.4942(a)-2 (c)(1), and any income attributable to 
such set-aside shall be taken into account in computing adjusted net 
income under Sec. 53.4942(a)-2(d).
    (9) Contingent set-aside. In the event a private foundation is 
involved in litigation and may not distribute assets or income because 
of a court order, the private foundation may (except as provided in 
Sec. 53.4942(a)-2 (e)(1)(i) or (ii)) seek and obtain a set-aside for a 
purpose described in Sec. 53.4942(a)-3 (a)(2). The amount to be set 
aside shall be equal to that portion of the private foundation's 
distributable amount which is attributable to the assets or income that 
are held pursuant to court order and which, but for the court order 
precluding the distribution of such assets or income, would have been 
distributed. In the event that the litigation encompasses more than one 
taxable year, the private foundation may seek additional contingent set-
asides. Such amounts must actually be distributed by the last day of the 
taxable year following the taxable year in which the litigation is 
terminated. Amounts not distributed by the close of the appropriate 
taxable year shall be treated as described in Sec. 53.4942(a)-2 
(d)(2)(iii)(c) for the succeeding taxable year.
    (c) Certain contributions to section 501(c)(3) organizations--(1) In 
general. For purposes of this section, the term ``qualifying 
distribution'' includes (in the year in which it is paid) a contribution 
to an exempt organization described in section 501(c)(3) and described 
in paragraph (a)(2)(i) (a) or (b) of this section if:
    (i) Not later than the close of the first taxable year after the 
donee organization's taxable year in which such contribution is 
received, such donee organization makes a distribution equal

[[Page 94]]

to the full amount of such contribution and such distribution is a 
qualifying distribution (within the meaning of paragraph (a) of this 
section, without regard to this paragraph) which is treated under 
paragraph (d) of this section 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
    (ii) The private foundation making the contribution obtains adequate 
records or other sufficient evidence from such donee organization (such 
as a statement by an appropriate officer, director, or trustee of such 
donee organization) showing (except as otherwise provided in this 
subparagraph) (a) that the qualifying distribution described in 
subdivision (i) of this subparagraph has been made by such organization, 
(b) the names and addresses of the recipients of such distribution and 
the amount received by each, and (c) that the distribution is treated as 
a distribution out of corpus under paragraph (d) of this section (or 
would be so treated if the donee organization were a private foundation 
which is not an operating foundation). Where a distribution is for an 
administrative expense which is part of a section 170(c) (1) or (2)(B) 
expenditure or is part of another section 170(c) (1) or (2)(B) 
expenditure that cannot reasonably be separately accounted for, the 
provisions of subdivision (ii) of this subparagraph may be satisfied by 
the submission by the donee organization of a statement setting forth 
the general purpose for which such expenditure was made and that the 
amount was distributed as a qualifying distribution described in 
subdivision (ii)(c) of this subparagraph.
    (2) Distribution requirements. (i) In order for a donee organization 
to meet the distribution requirements of subparagraph (1)(i) of this 
paragraph, it must, not later than the close of the first taxable year 
after its taxable year in which any contributions are received, 
distribute (within the meaning of this subparagraph) an amount equal in 
value to the contributions received in such prior taxable year and have 
no remaining undistributed income for such prior taxable year. In the 
event that a donee organization redistributes less than an amount equal 
to the total contributions from donor organizations which are required 
to be redistributed by such donee organization by the close of the first 
taxable year following the taxable year in which such contributions were 
received, amounts treated as redistributions of such contributions shall 
be deemed to have been made pro rata out of all such contributions 
regardless of any earmarking or identification made by such donee 
organization with respect to the source of such distributions. See 
paragraph (d)(2)(ix) of Sec. 53.4942(a)-2 for the treatment of amounts 
deemed not to have been so redistributed. For purposes of this 
paragraph, the term contributions means all contributions, whether of 
cash or property, and the fair market value of contributed property 
determined as of the date of the contribution must be used in 
determining whether an amount equal in value to the contributions 
received has been redistributed.
    (ii) For purposes of this paragraph, the characterization of 
qualifying distributions made during the taxable year (i.e., whether out 
of the prior year's undistributed income, the current year's 
undistributed income, or corpus) is to be made as of the close of the 
taxable year in question, except to the extent that a different 
characterization is effected by means of the election provided for by 
paragraph (d)(2) of this section or by subdivision (iv) of this 
subparagraph. Once it is determined that a qualifying distribution is 
attributable to corpus, such distribution will first be charged to 
distributions which are required to be redistributed under this 
paragraph.
    (iii) All amounts contributed to a specific exempt organization 
described in section 501(c)(3) and in paragraph (a)(2)(i) (a) or (b) of 
this section within any one taxable year of such organization shall be 
treated (with respect to the contributing private foundation) as one 
``contribution''. If subparagraph (1) (i) or (ii) of this paragraph is 
not completely satisfied with respect to such contribution within the 
meaning of such subparagraph, only that portion

[[Page 95]]

of such contribution which was redistributed (within the meaning of 
subparagraph (1) (i) and (ii) of this paragraph) shall be treated as a 
qualifying distribution.
    (iv) In order to satisfy distribution requirements under section 
170(b) (1)(E)(ii) or this paragraph, a donee organization may elect to 
treat as a current distribution out of corpus any amount distributed in 
a prior taxable year which was treated as a distribution out of corpus 
under paragraph (d)(1)(iii) of this section provided that (a) such 
amount has not been availed of for any other purpose, such as a 
carryover under paragraph (e) of this section or a redistribution under 
this paragraph for a prior year, (b) such corpus distribution occurred 
within the preceding 5 years, and (c) such amount is not later availed 
of for any other purpose. Such election must be made by attaching a 
statement to the return the foundation is required to file under section 
6033 with respect to the taxable year for which such election is to 
apply. Such statement must contain a declaration by an appropriate 
foundation manager (within the meaning of section 4946(b)(1)) that the 
foundation is making an election under this paragraph and it must 
specify that the distribution was treated under paragraph (d)(1)(iii) of 
this section as a distribution out of corpus in a designated prior 
taxable year (or years).
    (3) Examples. The provisions of subparagraphs (1) and (2) of this 
paragraph may be illustrated by the following examples. It is assumed in 
these examples that all private foundations described use the calendar 
as the taxable year.

    Example 1. In 1972 M, a private foundation, makes a contribution out 
of 1971 income to X, another private foundation which is not an 
operating foundation. The contribution is the only one received by X in 
1972. In 1973 X makes a qualifying distribution to an art museum 
maintained by an operating foundation in an amount equal to the amount 
of the contribution received from M. X also distributes all of its 
undistributed income for 1972 and 1973 for other purposes described in 
section 170(c)(2)(B). Under the provisions of paragraph (d) of this 
section, such distribution to the museum is treated as a distribution 
out of corpus. Thus, M's contribution to X is a qualifying distribution 
out of M's 1971 income provided M obtains adequate records or other 
sufficient evidence from X showing the nature and amount of the 
distribution made by X, the identity of the recipient, and the fact that 
the distribution is treated as made out of corpus. If X's qualifying 
distributions during 1973 had been equal only to M's contribution to X 
and X's undistributed income for 1972, X could have made an election 
under paragraph (d)(2) of this section to treat the amount distributed 
in excess of its 1972 undistributed income as a distribution out of 
corpus and in that manner satisfied the requirements of this paragraph.
    Example 2. Assume the facts stated in example (1), except that X is 
a private college described in section 170(b)(1)(A)(ii) which is 
controlled by disqualified persons with respect to M and that the 
records which X furnishes to M show that the distribution would have 
been treated as made out of corpus if X were a private nonoperating 
foundation. Under these circumstances, result is the same as in example 
(1).
    Example 3. Assume the facts stated in example (1), except that X 
makes a distribution to the museum equal only to one-half of the 
contribution from M, that the remainder of such contribution is added to 
X's funds and used to pay charitable administrative expenses, and that 
the records obtained by M from X are not sufficient to show the amounts 
distributed or the identities of the recipients of the distributions. 
The contribution by M to X will be a qualifying distribution only to the 
extent that M can obtain (i) other sufficient evidence (such as 
statements from officers or employees of X or from the museum) showing 
the facts required by subparagraph (1)(ii) (a), (b), and (c) of this 
paragraph and (ii) a statement from X setting forth that the remainder 
of the contribution was used for charitable administrative expenses 
which constituted qualifying distributions described in paragraph 
(a)(2)(i) of this section.
    Example 4. X and Y are private nonoperating foundations. A is an 
exempt organization which is not described in section 501(c)(3) but 
which supervises and conducts a program described in section 
170(c)(2)(B). Y, but not X, controls A within the meaning of paragraph 
(a)(3) of this section. In 1972, X and Y each makes a grant to A of 
$100, specifically designated for use in the operation of A's section 
170(c)(2)(B) program. X has made a qualifying distribution to A because 
the distribution is one described in paragraph (a)(2)(i) of this 
section. However, because A is controlled by Y, Y's grant of $100 to A 
does not constitute a qualifying distribution within the meaning of such 
paragraph (a)(2)(i). Furthermore, because A is not an exempt 
organization described in section 501(c)(3), Y's grant to A does not 
constitute a qualifying distribution by operation of the provisions of 
this paragraph.

[[Page 96]]

    Example 5. N, a private nonoperating foundation, had distributable 
amounts of $100 in 1970 and $125 in 1971. In 1970 N received total 
contributions of $540: $150 from Y, a public charity; $70 from Z, a 
private foundation; $140 from Q, a private foundation, subject to the 
requirement that N earmark the amount and distribute it before 
distributing Z's contribution; and, $180 from R, also a private 
foundation. However, R specifically instructed N that such contribution 
did not have to be redistributed because R already had made enough 
qualifying distributions to avoid all section 4942 taxes. N is not 
controlled by Y, Z, Q, or R, and N made no qualifying distributions in 
1970. By the close of 1971, N had made qualifying distributions of $420, 
earmarking $140 as having been a distribution of Q's contribution, but 
had made no election under paragraph (d)(2) of this section to have any 
amount distributed which was in excess of N's 1970 undistributed income 
treated as distributed out of corpus. Therefore, the first $225 of 
qualifying distributions made in 1971 (the sum of $100 and $125, N's 
distributable amounts for 1970 and 1971, respectively) are treated as 
amounts described in paragraph (d)(1) (i) and (ii) of this section. 
Since Y's contribution is a contribution from a public charity and does 
not have to be ``redistributed'' and since R specifically instructed N 
that its contribution need not be ``redistributed'', the remaining $195 
of qualifying distributions will be treated as distributed pro rata from 
Z's and Q's contributions, regardless of N's earmarking. Accordingly, of 
Z's original qualifying distribution of $70 only $65 ($195 multiplied by 
$70, Z's contribution, over $210, the total ($70 plus $140) of Z's and 
Q's contributions) will be treated as redistributed by N. Similarly, of 
Q's original qualifying distribution of $140 only $130 ($195 multiplied 
by $140 over $210) will be treated as redistributed by N. Thus, Z's 
gross income for 1972 will be increased by $5 ($70 less the $65 actually 
redistributed), and Q's gross income for 1972 will be increased by $10 
($140 less the $130 actually redistributed).

    (4) Limitation. A contribution by a private foundation to a donee 
organization which the donee uses to make payments to another 
organization (the secondary donee) shall not be regarded as a 
contribution by the private foundation to the secondary donee if the 
distributing foundation does not earmark the use of the contribution for 
any named secondary donee and does not retain power to cause the 
selection of the secondary donee by the organization to which such 
foundation has made the contribution. For purposes of this subparagraph, 
a contribution described herein shall not be regarded as a contribution 
by the foundation to the secondary donee even though such foundation has 
reason to believe that certain organizations would derive benefits from 
such contribution so long as the original donee organization exercises 
control, in fact, over the selection process and actually makes the 
selection completely independently of such foundation.
    (5) Transitional rule. (i) For purposes of this paragraph, a 
contribution to a private foundation which is not an operating 
foundation and which is not controlled (directly or indirectly) by the 
distributing foundation or one or more disqualified persons with respect 
to the distributing foundation will be treated as a contribution to an 
operating foundation if:
    (a) Such contribution is made pursuant to a written commitment which 
was binding on May 26, 1969, and at all times thereafter.
    (b) Such contribution is made for one or more of the purposes 
described in section 170(c) (1) or (2)(B), and
    (c) Such contribution is to be paid out to the donee private 
foundation on or before December 31, 1974.
    (ii) For purposes of this subparagraph, a written commitment will be 
considered to have been binding prior to May 27, 1969, only if the 
amount and nature of the contribution and the name of the donee 
foundation were entered in the records of the distributing foundation, 
or were otherwise adequately evidenced, prior to May 27, 1969, or notice 
of the contribution was communicated in writing to such donee prior to 
May 27, 1969.
    (d) Treatment of qualifying distributions--(1) In general. Except as 
provided in subparagraph (2) of this paragraph, any qualifying 
distribution made during a taxable year shall be treated as made:
    (i) First out of the undistributed income (as defined in paragraph 
(a) of Sec. 53.4942(a)-2) of the immediately preceding taxable year (if 
the private foundation was subject to the initial excise tax imposed by 
section 4942(a) for such preceding taxable year) to the extent thereof;

[[Page 97]]

    (ii) Second out of the undistributed income for the taxable year to 
the extent thereof; and
    (iii) Then out of corpus.
    (2) Election. In the case of any qualifying distribution which 
(under subparagraph (1) of this paragraph) is not treated as made out of 
the undistributed income of the immediately preceding taxable year, the 
foundation may elect to treat any portion of such distribution as made 
out of the undistributed income of a designated prior taxable year or 
out of corpus. Such election must be made by filing a statement with the 
Commissioner during the taxable year in which such qualifying 
distribution is made or by attaching a statement to the return the 
foundation is required to file under section 6033 with respect to the 
taxable year in which such qualifying distribution was made. Such 
statement must contain a declaration by an appropriate foundation 
manager (within the meaning of section 4946(b)(1)) that the foundation 
is making an election under this subparagraph, and it must specify 
whether the distribution is made out of the undistributed income of a 
designated prior taxable year (or years) or is made out of corpus. In 
any case where the election described in this subparagraph is made 
during the taxable year in which the qualifying distribution is made, 
such election may be revoked in whole or in part by filing a statement 
with the Commissioner during such taxable year revoking such election in 
whole or in part or by attaching a statement to the return the 
foundation is required to file under section 6033 with respect to the 
taxable year in which the qualifying distribution was made revoking such 
election in whole or in part. Such statement must contain a declaration 
by an appropriate foundation manager (within the meaning of section 
4946(b)(1)) that the foundation is revoking an election under this 
subparagraph in whole or in part, and it must specify the election or 
part thereof being revoked.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a private foundation which was created in 1968 and 
which uses the calendar year as the taxable year, has distributable 
amounts and qualifying distributions for 1970 through 1976 as follows:

------------------------------------------------------------------------
                                           1970    1971    1972    1973
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100    $100
Qualifying distribution.................       0     100     250     100
                                         -------------------------------
                                            1974    1975    1976  ......
                                         -------------------------------
Distributable amount....................    $100    $100    $100  ......
Qualifying distribution.................     100     100     100  ......
------------------------------------------------------------------------

    In 1971 the qualifying distribution of $100 is treated under 
subparagraph (1)(i) of this paragraph as made out of the $100 of 
undistributed income for 1970. The qualifying distribution of $250 in 
1972 is treated as made: (i) $100 out of the undistributed income for 
1971 under subparagraph (1)(i) of this paragraph; (ii) $100 out of the 
undistributed income for 1972 under subparagraph (1)(ii) of this 
paragraph; and (iii) $50 out of corpus in 1972 under subparagraph 
(1)(iii) of this paragraph. The qualifying distribution of $100 in each 
of the years 1973 through 1976 is treated as made out of the 
undistributed income for each of those respective years under 
subparagraph (1)(ii) of this paragraph. See paragraph (e) of this 
section for rules relating to the carryover of qualifying distributions 
out of corpus.
    Example 2. M, a private foundation which uses the calendar year as 
the taxable year, has undistributed income of $300 for 1981, $200 for 
1982, and $400 for 1983. On January 14, 1983, M makes its first 
qualifying distribution in 1983 when it sets aside (within the meaning 
of paragraph (b) of this section) $700 for construction of a hospital. 
On February 24, 1983 a notice of deficiency with respect to the excise 
taxes imposed by section 4942 (a) and (b) in regard to M 's 
undistributed income for 1981 is mailed to M under section 6212(a). M 
notifies the Commissioner in writing on March 24, 1983, that it is 
making an election under subparagraph (2) of this paragraph to have its 
distribution of January 14th applied first against its undistributed 
income for 1982, next against its undistributed income for 1981, and 
last against its undistributed income for 1983. Thus, $200 of the $700 
qualifying distribution is treated as made out of the undistributed 
income for 1982; $300, out of undistributed income for 1981; and $200 
($700 less the sum of $200 and $300), out of the undistributed income 
for 1983. Thus, an initial excise tax of $45 (15 percent of $300) is 
imposed under section 4942(a). Since M made the election described 
above, the $300 (treated as distributed out of undistributed income for 
1981) corrects (within the meaning of section 4963(d)(2)) the taxable 
act because the undistributed income for 1981 is reduced to zero. 
Furthermore, correction is effected within the correction period (as 
defined in section 4963(e)(1) and Sec. 53.4963-1(e)). Therefore, under 
the provisions of section

[[Page 98]]

4961(a), the additional tax imposed by section 4942(b) will not be 
assessed.

    (e) Carryover of excess qualifying distributions--(1) In general. If 
in any taxable year for which an organization is subject to the initial 
excise tax imposed by section 4942(a) there is created an excess of 
qualifying distributions (as determined under subparagraph (2) of this 
paragraph), such excess may be used to reduce distributable amounts in 
any taxable year of the adjustment period (as defined subparagraph (3) 
of this paragraph). For purposes of section 4942, including paragraph 
(d) of this section, the distributable amount for a taxable year in the 
adjustment period shall be reduced to the extent of the lesser of (i) 
the excess of qualifying distributions made in prior taxable years to 
which such adjustment period applies or (ii) the remaining undistributed 
income at the close of such taxable year after applying any qualifying 
distributions made in such taxable year to the distributable amount for 
such taxable year (determined without regard to this paragraph). If 
during any taxable year of the adjustment period there is created 
another excess of qualifying distributions, such excess shall not be 
taken into account until any earlier excess of qualifying distributions 
has been completely applied against distributable amounts during its 
adjustment period.
    (2) Excess qualifying distributions. An excess of qualifying 
distributions is created for any taxable year beginning after December 
31, 1969, if:
    (i) The total qualifying distributions treated (under paragraph (d) 
of this section) as made out of the undistributed income for such 
taxable year or as made out of corpus with respect to such taxable year 
(other than amounts distributed by an organization in satisfaction of 
section 170(b)(1)(E)(ii) or paragraph (c) of this section, or applied to 
a prior taxable year by operation of the elections contained in 
paragraphs (c)(2)(iv) and (d)(2) of this section), exceeds
    (ii) The distributable amount for such taxable year (determined 
without regard to this paragraph).
    (3) Adjustment period. For purposes of this paragraph, the taxable 
years in the adjustment period are the 5 taxable years immediately 
following the taxable year in which the excess of qualifying 
distributions is created. Thus, an excess (within the meaning of 
subparagraph (2) of this paragraph) for any 1 taxable year cannot be 
carried over beyond the succeeding 5 taxable years. However, if during 
any taxable year in the adjustment period an organization ceases to be 
subject to the initial excise tax imposed by section 4942(a), any 
portion of the excess of qualifying distributions, which prior to such 
taxable year has not been applied against distributable amounts, may not 
be carried over to such taxable year or subsequent taxable years in the 
adjustment period, even if during any of such taxable years the 
organization again becomes subject to the initial excise tax imposed by 
section 4942(a).
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. (i) F, a private foundation which was created in 1967 and 
which uses the calendar year as the taxable year, has distributable 
amounts and qualifying distributions for 1970 through 1976 as follows:

------------------------------------------------------------------------
                  Year                     1970    1971    1972    1973
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100    $100
Qualifying distribution.................       0    $250     $70    $140
------------------------------------------------------------------------


------------------------------------------------------------------------
                  Year                     1974    1975    1976
------------------------------------------------------------------------
Distributable amount....................    $100    $100    $100  ......
Qualifying distribution.................     $60     $75    $105  ......
------------------------------------------------------------------------

    (ii) The qualifying distributions made in 1971 will be treated under 
paragraph (d) of this section as $100 made out of the undistributed 
income for 1970, then as $100 made out of the undistributed income for 
1971, and finally as $50 out of corpus in 1971. Since the total 
qualifying distributions for 1971 ($150) exceed the distributable amount 
for 1971 ($100), there exists a $50 excess of qualifying distributions 
which F may use to reduce its distributable amounts for the years 1972 
through 1976 (the taxable years in the adjustment period with respect to 
the 1971 excess). Therefore, the $100 distributable amount for 1972 is 
reduced by $30 (the lesser of the 1971 excess ($50) and the remaining 
undistributed income at the close of 1972 ($30), after the qualifying 
distributions of $70 for 1972 were applied to the original distributable 
amount for 1972 of $100). Since the distributable amount for 1972 was 
reduced to $70, there is no remaining undistributed income for 1972. 
Accordingly, the qualifying distributions made in 1973 will be treated 
as $100 made out

[[Page 99]]

of the undistributed income for 1973 and as $40 out of corpus in 1973. 
Since this amount ($140) exceeds the distributable amount for 1973 
($100), there exists a $40 excess which F may use to reduce its 
distributable amounts for the years 1974 through 1978 (the taxable years 
in the adjustment period with respect to the 1973 excess). However, in 
accordance with subparagraph (1) of this paragraph such excess may not 
be used to reduce F's distributable amounts for the years 1974 through 
1976 until the excess created in 1971 has been completely applied 
against distributable amounts during such years. The distributable 
amount for 1974 is reduced by $40 (the lesser of the unused portion of 
the 1971 excess ($20) plus the 1973 excess ($40) and the remaining 
undistributed income at the close of 1974 ($40), after the qualifying 
distributions of $60 for 1974 were applied to the original distributable 
amount for 1974 of $100). The distributable amount for 1975 is reduced 
by $20 (the lesser of the unused portion of the 1973 excess of 
qualifying distributions ($20) and the remaining undistributed income at 
the close of 1975 ($25), after the qualifying distributions of $75 for 
1975 were applied to the original distributable amount for 1975 of 
$100). Consequently, qualifying distributions made in 1976 will be 
treated as made first out of the $5 of remaining undistributed income 
for 1975 and then as $100 made out of the undistributed income for 1976.
    Example 2. Assume the facts as stated in example (1), except that in 
1974 F receives a contribution of $300 from G, a private foundation 
which controls F (within the meaning of paragraph (a)(3) of this 
section), and F distributes such contribution in 1975 in satisfaction of 
paragraph (c) of this section. Under these circumstances, there would be 
no excess of qualifying distributions for 1975 with respect to such 
distribution, since such distribution is excluded from the computation 
of an excess of qualifying distributions by operation of subparagraph 
(2)(i) of this paragraph.
    Example 3. Assume the facts as stated in example (1), except that in 
1972 F is treated as an operating foundation (as such term is defined in 
section 4942(j)(3)). In accordance with subparagraph (3) of this 
paragraph since F is not subject to the initial excise tax imposed by 
section 4942(a) for 1972, the 1971 excess cannot be carried forward to 
1972 or any subsequent year in the adjustment period with respect to the 
1971 excess, even if F is subsequently treated as a private nonoperating 
foundation for any year during the period 1973 through 1976.

[T.D. 7256, 38 FR 3323, Feb. 5, 1973, as amended by T.D. 7486, 42 FR 
24265, May 13, 1977; T.D. 7849, 47 FR 50857, Nov. 10, 1982; T.D. 7938, 
49 FR 3848, Jan. 31, 1984; T.D. 8084, 51 FR 16302, May 2, 1986]



Sec. 53.4942(b)-1  Operating foundations.

    (a) Operating foundation defined--(1) In general. For purposes of 
section 4942 and the regulations thereunder, the term ``operating 
foundation'' means any private foundation which, in addition to 
satisfying the assets test, the endowment test or the support test set 
forth in Sec. 53.4942(b)-2 (a), (b) and (c), makes qualifying 
distributions (within the meaning of Sec. 53.4942(a)-3(a)(2)) directly 
for the active conduct of activities constituting its charitable, 
educational, or other similar exempt purpose equal in value to:
    (i) For taxable years beginning before January 1, 1982, 
substantially all of the foundation's adjusted net income (as defined in 
Sec. 53.4942(a)-2(d)); and
    (ii) For taxable years beginning after December 31, 1981, 
substantially all of the lesser of the foundation's adjusted net income 
(as defined in Sec. 53.4942(a)-2(d)) or minimum investment return (as 
defined in Sec. 53.4942(a)-2(c)). If the foundation's qualifying 
distributions exceed its minimum investment return (but are less than 
the foundation's adjusted net income) substantially all of such 
qualifying distributions must be made directly for the active conduct of 
activities constituting its charitable, educational or other similar 
exempt purpose. However, if the foundation's minimum investment return 
is less than its adjusted net income and the foundation's qualifying 
distributions equal or exceed such adjusted net income, only that 
portion of the qualifying distributions equal to substantially all of 
the foundation's adjusted net income must be made directly for the 
active conduct of activities constituting its charitable, educational or 
other similar exempt purpose.
    (2) Certain elderly care facilities described in section 
4942(j)(6)--(i) In general. For purposes of the distribution 
requirements of section 4942 (but no other provision of the Internal 
Revenue Code) and for taxable years beginning after December 31, 1969, 
the term ``operating foundation'' includes a private foundation which:
    (A) On or before May 26, 1969, and continuously thereafter to the 
close of the taxable year, operates and maintains, as its principal 
functional purpose, residential facilities for the long-

[[Page 100]]

term care, comfort, maintenance, or education of permanently and totally 
disabled persons, elderly persons, needy widows, or children, and
    (B) Satisfies the endowment test set forth in Sec. 53.4942(b)-2 
(b).
    (ii) Principal functional purpose. For purposes of section 
4942(j)(6) and this subparagraph (2), an organization's ``principal 
functional purpose'' is operating and maintaining residential facilities 
for the long-term care, comfort, maintenance, or education of 
permanently and totally disabled persons, elderly persons, needy widows, 
or children, if it is organized for the principal purpose of operating 
and maintaining such residential facilities and is primarily engaged 
directly in the operation and maintenance of those facilities. An 
organization will be treated as being primarily engaged directly in the 
operation and maintenance of the described residential facilities if at 
least 50% of the qualifying distributions (as defined in Sec. 
53.4942(a)-3(a)(2)) normally made by the organization are expended for 
the operation and maintenance of the facilities.
    (b) Active conduct of activities constituting the exempt purpose--
(1) In general. For purposes of this section, except as provided in 
subparagraph (2) or (3) of this paragraph, qualifying distributions are 
not made by a foundation ``directly for the active conduct of activities 
constituting its charitable, educational, or other similar exempt 
purpose'' unless such qualifying distributions are used by the 
foundation itself, rather than by or through one or more grantee 
organizations which receive such qualifying distributions directly or 
indirectly from such foundation. Thus, grants made to other 
organizations to assist them in conducting activities which help to 
accomplish their charitable, educational, or other similar exempt 
purpose are considered an indirect, rather than direct, means of 
carrying out activities constituting the charitable, educational, or 
other similar exempt purpose of the grantor foundation, regardless of 
the fact that the exempt activities of the grantee organization may 
assist the grantor foundation in carrying out its own exempt activities. 
However, amounts paid to acquire or maintain assets which are used 
directly in the conduct of the foundation's exempt activities, such as 
the operating assets of a museum, public park, or historic site, are 
considered direct expenditures for the active conduct of the 
foundation's exempt activities. Likewise, administrative expenses (such 
as staff salaries and traveling expenses) and other operating costs 
necessary to conduct the foundation's exempt activities (regardless of 
whether they are ``directly for the active conduct'' of such exempt 
activities) shall be treated as qualifying distributions expended 
directly for the active conduct of such exempt activities if such 
expenses and costs are reasonable in amount. Conversely, administrative 
expenses and operating costs which are not attributable to exempt 
activities, such as expenses in connection with the production of 
investment income, are not treated as such qualifying distributions. 
Expenses attributable to both exempt and nonexempt activities shall be 
allocated to each such activity on a reasonable and consistently applied 
basis. Any amount set aside by a foundation for a specific project, such 
as the acquisition and restoration, or construction, of additional 
buildings or facilities which are to be used by the foundation directly 
for the active conduct of the foundation's exempt activities, shall be 
deemed to be qualifying distributions expended directly for the active 
conduct of the foundation's exempt activities if the initial setting 
aside of the funds constitutes a set-aside within the meaning of 
paragraph (b) of Sec. 53.4942(a)-3.
    (2) Payments to individual beneficiaries--(i) In general. If a 
foundation makes or awards grants, scholarships, or other payments to 
individual beneficiaries (including program related investments within 
the meaning of section 4944(c) made to individuals or corporate 
enterprises) to support active programs conducted to carry out the 
foundation's charitable, educational, or other similar exempt purpose, 
such grants, scholarships, or other payments will be treated as 
qualifying distributions made directly for the active conduct of exempt 
activities for purposes of paragraph (a) of this section only if the 
foundation, apart from the

[[Page 101]]

making or awarding of the grants, scholarships, or other payments, 
otherwise maintains some significant involvement (as defined in 
subdivision (ii) of this subparagraph) in the active programs in support 
of which such grants, scholarships, or other payments were made or 
awarded. Whether the making or awarding of grants, scholarships, or 
other payments constitutes qualifying distributions made directly for 
the active conduct of the foundation's exempt activities is to be 
determined on the basis of the facts and circumstances of each 
particular case. The test applied is a qualitative, rather than a 
strictly quantitative, one. Therefore, if the foundation maintains a 
significant involvement (as defined in subdivision (ii) of this 
subparagraph) it will not fail to meet the general rule of subparagraph 
(1) of this paragraph solely because more of its funds are devoted to 
the making or awarding of grants, scholarships, or other payments than 
to the active programs which such grants, scholarships, or other 
payments support. However, if a foundation does no more than select, 
screen, and investigate applicants for grants or scholarships, pursuant 
to which the recipients perform their work or studies alone or 
exclusively under the direction of some other organization, such grants 
or scholarships will not be treated as qualifying distributions made 
directly for the active conduct of the foundation's exempt activities. 
The administrative expenses of such screening and investigation (as 
opposed to the grants or scholarships themselves) may be treated as 
qualifying distributions made directly for the active conduct of the 
foundation's exempt activities.
    (ii) Definition. For purposes of this subparagraph, a foundation 
will be considered as maintaining a ``significant involvement'' in a 
charitable, educational, or other similar exempt activity in connection 
with which grants, scholarships, or other payments are made or awarded 
if:
    (A) An exempt purpose of the foundation is the relief of poverty or 
human distress, and its exempt activities are designed to ameliorate 
conditions among a poor or distressed class of persons or in an area 
subject to poverty or national disaster (such as providing food or 
clothing to indigents or residents of a disaster area), the making or 
awarding of the grants or other payments to accomplish such exempt 
purpose is direct and without the assistance of an intervening 
organization or agency, and the foundation maintains a salaried or 
voluntary staff of administrators, researchers, or other personnel who 
supervise and direct the activities described in this subdivision (A) on 
a continuing basis; or
    (B) The foundation has developed some specialized skills, expertise, 
or involvement in a particular discipline or substantive area (such as 
scientific or medical research, social work, education, or the social 
sciences), it maintains a salaried staff of administrators, researchers, 
or other personnel who supervise or conduct programs or activities which 
support and advance the foundation's work in its particular area of 
interest, and, as a part of such programs or activities, the foundation 
makes or awards grants, scholarships, or other payments to individuals 
to encourage and further their involvement in the foundation's 
particular area of interest and in some segment of the programs or 
activities carried on by the foundation (such as grants under which the 
recipients, in addition to independent study, attend classes, seminars, 
or conferences sponsored or conducted by the foundation, or grants to 
engage in social work or scientific research projects which are under 
the general direction and supervision of the foundation).
    (3) Payment of section 4940 tax. For purposes of section 4942(j)(3) 
(A) and (B)(ii), payment of the tax imposed upon a foundation under 
section 4940 shall be considered a qualifying distribution which is made 
directly for the active conduct of activities constituting the 
foundation's charitable, educational, or other similar exempt purpose.
    (c) Substantially all. For purposes of this section, the term 
``substantially all'' shall mean 85 percent or more. Thus, if a 
foundation makes qualifying distributions directly for the active 
conduct of activities constituting its charitable, educational, or other 
similar exempt purpose in an amount equal

[[Page 102]]

to at least 85 percent of its adjusted net income, it will be considered 
as satisfying the income test described in this section even if it makes 
grants to organizations or engages in other activities with the 
remainder of its adjusted net income and with other funds. In 
determining whether the amount of qualifying distributions made directly 
for the active conduct of such exempt activities equals at least 85 
percent of a foundation's adjusted net income, a foundation is not 
required to trace the source of such expenditures to determine whether 
they were derived from income or from contributions.
    (d) Examples. The provisions of this section may be illustrated by 
the following examples. It is assumed that none of the organizations 
described in these examples is described in section 509(a) (1), (2), or 
(3).

    Example 1. N, an exempt museum described in section 501(c)(3), was 
founded by the gift of an endowment from a single contributor. N uses 90 
percent of its adjusted net income to operate the museum. If N satisfies 
one of the tests set forth in Sec. 53.4942(b)-2 it may be classified as 
an operating foundation since substantially all of the qualifying 
distributions made by N are used directly for the active conduct of N's 
exempt activities within the meaning of paragraph (b)(1) of this 
section.
    Example 2. M, an exempt organization described in section 501(c)(3), 
was created to improve conditions in a particular urban ghetto. M 
receives its funds primarily from a limited number of wealthy 
contributors interested in helping carry out its exempt purpose. M's 
program consists of making a survey of the problems of the ghetto to 
determine the areas in which its funds may be applied most effectively. 
Approximately 10 percent of M's adjusted net income is used to conduct 
this survey. The balance of its income is used to make grants to other 
nonprofit organizations doing work in the ghetto in those areas 
determined to have the greatest likelihood of resulting in improved 
conditions. Under these circumstances, since only 10 percent of M's 
adjusted net income may be considered as constituting qualifying 
distributions made directly for the active conduct of M's exempt 
activities, M cannot qualify as an operating foundation.
    Example 3. Assume the facts as stated in example (2), except that M 
uses the remaining 90 percent of its adjusted net income for the 
following purposes: (1) M maintains a salaried staff of social workers 
and researchers who analyze its surveys and make recommendations as to 
methods for improving ghetto conditions; (2) M makes grants to 
independent social scientists who assist in these analyses and 
recommendations; (3) M publishes periodic reports indicating the results 
of its surveys and recommendations; (4) M makes grants to social workers 
and others who act as advisers to nonprofit organizations, as well as 
small business enterprises, functioning in the community (these advisers 
acting under the general direction of M attempt to implement M's 
recommendations through their advice and assistance to the nonprofit 
organizations and small business enterprises); and (5) M makes grants to 
other social scientists who study and report on the success of the 
various enterprises which attempt to implement M's recommendations. 
Under these circumstances, M satisfies the requirements of paragraph (b) 
(2) of this section, and the various grants it makes constitute 
qualifying distributions made directly for the active conduct of its 
exempt activities. Thus, if M satisfies one of the tests set forth in 
Sec. 53.4942(b)-2 it may be classified as an operating foundation.
    Example 4. P, an exempt educational organization described in 
section 501(c)(3), was created for the purpose of training teachers for 
institutions of higher education. Each year P awards a substantial 
number of fellowships to students for graduate study leading toward 
their M.A. or Ph. D. degrees. The applicants for these fellowships are 
carefully screened by P's staff, and only those applicants who indicate 
a strong interest in teaching in colleges or universities are chosen. P 
publishes and circulates various pamphlets encouraging a development of 
interest in college teaching and describing its fellowships. P also 
conducts annual summer seminars which are attended by its fellowship 
recipients, its staff, consultants, and other interested parties. The 
purpose of these seminars is to foster and encourage the development of 
college teaching. P publishes a report of the seminar proceedings along 
with related studies written by those who attended. Despite the fact 
that a substantial portion of P's adjusted net income is devoted to 
granting fellowships, its commitment to encouraging individuals to 
become teachers at institutions of higher learning, its maintenance of a 
staff and programs designed to further this purpose, and the granting of 
fellowships to encourage involvement both in its own seminars and in its 
exempt purpose indicate a significant involvement by P beyond the mere 
granting of fellowships. Thus, the fellowship grants made by P 
constitute qualifying distributions made directly for the active conduct 
of P's exempt activities within the meaning of paragraph (b) (2) of this 
section.
    Example 5. Q, an exempt organization described in section 501(c) 
(3), is composed of professional organizations interested in different 
branches of one academic discipline. Q

[[Page 103]]

trains its own professional staff, conducts its own program of research, 
selects research topics, screens and investigates grant recipients, 
makes grants to those selected, and sets up and conducts conferences and 
seminars for the grantees. Q has particular knowledge and skill in the 
given discipline, carries on activities to advance its study of that 
discipline, and makes grants to individuals to enable them to 
participate in activities which it conducts in carrying out its exempt 
purpose. Under these circumstances, Q's grants constitute qualifying 
distributions made directly for the active conduct of Q's exempt 
activities within the meaning of paragraph (b) (2) of this section.
    Example 6. R, an exempt medical research organization described in 
section 501 (c) (3), was created to study and perform research 
concerning heart disease. R has its own research center in which it 
carries on a broad number of research projects in the field of heart 
disease with its own professional staff. Physicians and scientists who 
are interested in special projects in this area present the plans for 
their projects to R. The directors of R study these plans and decide if 
the project is feasible and will further the work being done by R. If it 
is, R makes a grant to the individual to enable him to carry out his 
project, either at R's facilities or elsewhere. Reports of the progress 
of the project are made periodically to R, and R exercises a certain 
amount of supervision over the project. The resulting findings of these 
projects are usually published by R. Under these circumstances, the 
grants made by R constitute qualifying distributions made directly for 
the active conduct of R's exempt activities within the meaning of 
paragraph (b) (2) of this section.
    Example 7. S, an exempt organization described in section 501(c) 
(3), maintains a large library of manuscripts and other historical 
reference material relating to the history and development of the region 
in which the collection is located. S makes a limited number of annual 
grants to enable post-doctoral scholars and doctoral candidates to use 
its library. Sometimes S obtains the right to publish the scholar's 
work, although this is not a prerequisite to the receipt of a grant. The 
primary criterion for selection of grant recipients is the usefulness of 
the library's resources to the applicant's field of study. Under these 
circumstances, the grants made by S constitute qualifying distributions 
made directly for the active conduct of S's exempt activities within the 
meaning of paragraph (b) (2) of this section.
    Example 8. T, an exempt charitable organization described in section 
501(c)(3), was created by the members of one family for the purpose of 
relieving poverty and human suffering. T has a large salaried staff of 
employees who operate offices in various areas throughout the country. 
Its employees make gifts of food and clothing to poor persons in the 
area serviced by each office. On occasion, T also provides temporary 
relief in the form of food and clothing to persons in areas stricken by 
natural disasters. If conditions improve in one poverty area, T 
transfers the resources of the office in that area to another poverty 
area. Under these circumstances, the gifts of food and clothing made by 
T constitute qualifying distributions made directly for the active 
conduct of T's exempt activities within the meaning of paragraph (b) (2) 
of this section.
    Example 9. U, an exempt scientific organization described in section 
501(c) (3), was created for the principal purpose of studying the 
effects of early childhood brain damage. U conducts an active and 
continuous research program in this area through a salaried staff of 
scientists and physicians. As part of its research program, U awards 
scholarships to young people suffering mild brain damage to enable them 
to attend special schools equipped to handle such problems. The 
recipients are periodically tested to determine the effect of such 
schooling upon them. Under these circumstances, the scholarships awarded 
by U constitute qualifying distributions made directly for the active 
conduct of U's exempt activities within the meaning of paragraph (b) (2) 
of this section.
    Example 10. O, an exempt charitable organization described in 
section 501(c) (3), was created for the purpose of giving scholarships 
to children of the employees of X Corporation who meet the standards set 
by O. O not only screens and investigates each applicant to make sure 
that he complies with the academic and financial requirements set for 
scholarship recipients, but also administers an examination which each 
applicant must take--90 percent of O's adjusted net income is used in 
awarding these scholarships to the chosen applicants. O does not conduct 
any activities of an educational nature on its own. Under these 
circumstances, O is not using substantially all of its adjusted net 
income directly for the active conduct of its exempt activities within 
the meaning of paragraph (b) of this section. Thus, O is not an 
operating foundation because it fails to satisfy the income test set 
forth in paragraph (a) of this section.

[T.D. 7249, 38 FR 768, Jan. 4, 1973, as amended by T.D. 7718, 45 FR 
58520, Sept. 4, 1980; 46 FR 11254, Feb. 6, 1981; T.D. 7878, 48 FR 11943, 
Mar. 22, 1983]



Sec. 53.4942(b)-2  Alternative tests.

    (a) Assets test--(1) In general. A private foundation will satisfy 
the assets test under the provisions of this paragraph if substantially 
more than half of the foundation's assets:

[[Page 104]]

    (i) Are devoted directly (A) to the active conduct of activities 
constituting the foundation's charitable, educational, or other similar 
exempt purpose, (B) to functionally related businesses (as defined in 
paragraph (c)(3)(iii) of Sec. 53.4942(a)-2), or (C) to any combination 
thereof;
    (ii) Are stock of a corporation which is controlled by the 
foundation (within the meaning of section 368(c)) and substantially all 
the assets of which (within the meaning of paragraph (c) of Sec. 
53.4942(b)-1) are so devoted; or
    (iii) Are in part assets which are described in subdivision (i) of 
this subparagraph and in part stock which is described in subdivision 
(ii) of this subparagraph.
    (2) Qualifying assets--(i) In general. For purposes of subparagraph 
(1) of this paragraph, an asset is ``devoted directly to the active 
conduct of activities constituting the foundation's charitable, 
educational, or other similar exempt purpose'' only if the asset is 
actually used by the foundation directly for the active conduct of 
activities constituting its charitable, educational, or other similar 
exempt purpose. Thus, such assets as real estate, physical facilities or 
objects (such as museum assets, classroom fixtures and equipment, and 
research facilities), and intangible assets (such as patents, 
copyrights, and trademarks) will be considered qualifying assets for 
purposes of this paragraph to the extent they are used directly for the 
active conduct of the foundation's exempt activities. However, assets 
which are held for the production of income, for investment, or for some 
other similar use (for example, stocks, bonds, interest-bearing notes, 
endowment funds, or, generally, leased real estate) are not devoted 
directly to the active conduct of the foundation's exempt activities, 
even though the income derived from such assets is used to carry out 
such exempt activities. Whether an asset is held for the production of 
income, for investment, or for some other similar use rather than being 
used for the active conduct of the foundation's exempt activities is a 
question of fact. For example, an office building used for the purpose 
of providing offices for employees engaged in the management of 
endowment funds of the foundation is not devoted to the active conduct 
of the foundation's exempt activities. However, where property is used 
both for exempt purposes and for other purposes, if such exempt use 
represents 95 percent or more of the total use, such property shall be 
considered to be used exclusively for an exempt purpose. Property 
acquired by a foundation to be used in carrying out the foundation's 
exempt purpose may be considered as devoted directly to the active 
conduct of such purpose even though the property, in whole or in part, 
is leased for a limited period of time during which arrangements are 
made for its conversion to the use for which it was acquired, provided 
such income-producing use of the property does not exceed a reasonable 
period of time. Generally, 1 year shall be deemed to be a reasonable 
period of time for purposes of the immediately preceding sentence. 
Similarly, where property is leased by a foundation in carrying out its 
exempt purpose and where the rental income derived from such property by 
the foundation is less than the amount which would be required to be 
charged in order to recover the cost of purchase and maintenance of such 
property (taking into account the deductions permitted by paragraph 
(d)(4) of Sec. 53.4942(a)-2), such property shall be considered devoted 
directly to the active conduct of the foundation's exempt activities.
    (ii) Limitations. (A) Assets which are held for the purpose of 
extending credit or making funds available to members of a charitable 
class (including any interest in a program related-investment, except as 
provided in paragraph (b)(2) of Sec. 53.4942(b)-1) are not considered 
assets devoted directly to the active conduct of activities constituting 
the foundation's charitable, educational, or other similar exempt 
purpose. For example, assets which are set aside in special reserve 
accounts to guarantee student loans made by lending institutions will 
not be considered assets devoted directly to the active conduct of the 
foundation's exempt activities.
    (B) Any amount set aside by a foundation within the meaning of 
paragraph (b) (1) of Sec. 53.4942(b)-1 shall not be treated as an asset 
devoted directly to

[[Page 105]]

the active conduct of the foundation's exempt activities.
    (3) Assets held for less than a taxable year. For purposes of this 
paragraph, any asset which is held by a foundation for part of a taxable 
year shall be taken into account for such taxable year by multiplying 
the fair market value of such asset (as determined pursuant to 
subparagraph (4) of this paragraph) by a fraction, the numerator of 
which is the number of days in such taxable year that the foundation 
held such asset and the denominator of which is the number of days in 
such taxable year.
    (4) Valuation. For purposes of this paragraph, all assets shall be 
valued at their fair market value. Fair market value shall be determined 
in accordance with the rules set forth in paragraph (c)(4) of Sec. 
53.4942(a)-2, except in the case of assets which are devoted directly to 
the active conduct of the foundation's exempt activities and for which 
neither a ready market nor standard valuation methods exist (such as 
historical objects or buildings, certain works of art, and botanical 
gardens). In such cases, the historical cost (unadjusted for 
depreciation) shall be considered equal to fair market value unless the 
foundation demonstrates that fair market value is other than cost. In 
any case in which the foundation so demonstrates that the fair market 
value of an asset is other than historical cost, such substituted 
valuation may be used for the taxable year for which such new valuation 
is demonstrated and for each of the succeeding 4 taxable years if the 
valuation methods and procedures prescribed by paragraph (c)(4)(iv)(B) 
of Sec. 53.4942 (a)-2 are followed.
    (5) Substantially more than half. For purposes of this paragraph, 
the term substantially more than half shall mean 65 percent or more.
    (6) Examples. The provisions of this paragraph may be illustrated by 
the following examples. It is assumed that none of the organizations 
described in these examples is described in section 509(a) (1), (2), or 
(3).

    Example 1. W, an exempt organization described in section 501(c)(3), 
is devoted to the maintenance and operation of a historic area for the 
benefit of the general public. W has acquired and erected facilities for 
lodging and other visitor accommodations in such area, which W operates 
through a wholly owned, separately incorporated, taxable entity. These 
facilities comprise substantially all of the subsidiary's assets. The 
operation of such accommodations constitutes a functionally related 
business within the meaning of paragraph (c)(3)(iii) of Sec. 
53.4942(a)-2. Under these circumstances, the stock of the subsidiary 
will be considered as part of W's assets which may be taken into account 
by W in determining whether it satisfies the assets test described in 
this paragraph.
    Example 2. M, an exempt conservation organization described in 
section 501(c)(3), is devoted to acquiring, preserving, and otherwise 
making available for public use geographically diversified areas of 
natural beauty. M has acquired and erected facilities for lodging and 
other visitor accommodations in national park areas. The operation of 
such accommodations constitutes a functionally related business within 
the meaning of paragraph (c)(3)(iii) of Sec. 53.4942(a)-2. Therefore, 
M's assets which are directly devoted to such visitor accommodations may 
be taken into account by M in determining whether it satisfies the 
assets test described in this paragraph.
    Example 3. P, an exempt organization described in section 501(c)(3), 
is devoted to acquiring and restoring historic houses. To insure that 
the restored houses will be kept in the restored condition, and to make 
the houses more readily available for public display, P rents the houses 
rather than sells them once they have been restored. The rental income 
derived by P is substantially less than the amount which would be 
required to be charged in order to recover the cost of purchase, 
restoration, and maintenance of such houses. Therefore, such houses may 
be taken into account by P in determining whether it satisfies the 
assets test described in this paragraph.
    Example 4. Z, an exempt organization described in section 501(c)(3), 
is devoted to improving the public's understanding of Renaissance art. 
Z's principal assets are a number of paintings of this period which it 
circulates on an active and continuing basis to museums and schools for 
public display. These paintings constitute 80 percent of Z's assets. 
Under these circumstances, although Z does not have a building in which 
it displays these paintings, such paintings are devoted directly to the 
active conduct of activities constituting Z's exempt purpose. Therefore, 
Z has satisfied the assets test described in this paragraph.

    (b) Endowment test--(1) In general. A foundation will satisfy the 
endowment test under the provisions of this paragraph if it normally 
makes qualifying distributions (within the meaning of

[[Page 106]]

paragraph (a)(2) of Sec. 53.4942(a)-3) directly for the active conduct 
of activities constituting its charitable, educational, or other similar 
exempt purpose in an amount not less than two-thirds of its minimum 
investment return (as defined in paragraph (c) of Sec. 53.4942(a)-2). 
In determining whether the amount of such qualifying distributions is 
not less than an amount equal to two-thirds of the foundation's minimum 
investment return, the foundation is not required to trace the source of 
such expenditures to determine whether they were derived from investment 
income or from contributions.
    (2) Definitions. For purposes of this paragraph, the phrase directly 
for the active conduct of activities constituting the foundation's 
charitable, educational, or other similar exempt purpose shall have the 
same meaning as in paragraph (b) of Sec. 53.4942(b)-1.
    (3) Example. This paragraph may be illustrated by the following 
example:

    Example. X, an exempt organization described in section 501(c)(3) 
and not described in section 509(a) (1), (2), or (3), was created on 
July 15, 1970. X uses the cash receipts and disbursements method of 
accounting. For 1971, the fair market value of X's assets not described 
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 is $400,000. X makes 
qualifying distributions for 1971 directly for the active conduct of its 
exempt activities of $17,000. For 1971 two-thirds of X's minimum 
investment return is $16,000 (6 percent x $400,000 = $24,000; \2/3\ x 
$24,000 = $16,000). Under these circumstances, X has satisfied the 
endowment test described in this paragraph for 1971. However, if X's 
qualifying distributions for 1971 directly for the active conduct of its 
exempt activities were only $15,000, X would not satisfy the endowment 
test for 1971, unless the fair market value of its assets not described 
in paragraph (c) (2) or (3) of Sec. 53.4942(a)-2 were no greater than 
$375,000 (6 percent x $375,000 = $22,500; \2/3\ x $22,500 = $15,000).

    (c) Support test--(1) In general. A foundation will satisfy the 
support test under the provisions of this paragraph if:
    (i) Substantially all of its support (other than gross investment 
income as defined in section 509(e)) is normally received from the 
general public and from five or more exempt organizations which are not 
described in section 4946(a)(1)(H) with respect to each other or the 
recipient foundation;
    (ii) Not more than 25 percent of its support (other than gross 
investment income) is normally received from any one such exempt 
organization; and
    (iii) Not more than half of its support is normally received from 
gross investment income.
    (2) Definitions and special rules. For purposes of this paragraph:
    (i) Support. The term support shall have the same meaning as in 
section 509(d).
    (ii) Substantially all. The term substantially all shall have the 
same meaning as in paragraph (c) of Sec. 53.4942(b)-1.
    (iii) Support from exempt organizations. The support received from 
any one exempt organization may be counted towards satisfaction of the 
support test described in this paragraph only if the foundation receives 
support from no fewer than five exempt organizations. For example, a 
foundation which normally receives 20 percent of its support (other than 
gross investment income) from each of five exempt organizations may 
qualify under this paragraph even though it receives no support from the 
general public. However, if a foundation normally received 10 percent of 
its support from each of three exempt organizations and the balance of 
its support from sources other than exempt organizations, such support 
could not be taken into account in determining whether the foundation 
had satisfied the support test set forth in this paragraph.
    (iv) Support from the general public. ``Support'' received from an 
individual, or from a trust or corporation (other than an exempt 
organization), shall be taken into account as support from the general 
public only to the extent that the total amount of the support received 
from any such individual, trust, or corporation during the period for 
determining the normal sources of the foundation's support (as set forth 
in Sec. 53.4942 (b)-3) does not exceed 1 percent of the foundation's 
total support (other than gross investment income) for such period. In 
applying this 1-percent limitation, all support received by the 
foundation from any person and from any other person or persons standing 
in a relationship to such person which is described in section 
4946(a)(1) (C)

[[Page 107]]

through (G) and the regulations thereunder shall be treated as received 
from one person. For purposes of this paragraph, support received from a 
governmental unit described in section 170(c)(1) shall be treated as 
support received from the general public, but shall not be subject to 
the 1-percent limitation.



Sec. 53.4942(b)-3  Determination of compliance with operating foundation tests.

    (a) In general. A foundation may satisfy the income test and either 
the assets, endowment, or support test by satisfying such tests for any 
3 taxable years during a 4-year period consisting of the taxable year in 
question and the three immediately preceding taxable years or on the 
basis of an aggregation of all pertinent amounts of income or assets 
held, received, or distributed during such 4-year period. A foundation 
may not use one method for satisfying the income test described in 
paragraph (a) of Sec. 53.4942(b)-1 and another for satisfying either 
the assets, endowment, or support test described in Sec. 53.4942(b)-2. 
Thus, if a foundation satisfies the income test on the 3-out-of-4-year 
basis for a particular taxable year, it may not use the aggregation 
method for satisfying either the assets, endowment, or support test for 
such particular taxable year. However, the fact that a foundation has 
chosen one method for satisfying the tests under Sec. Sec. 53.4942(b)-1 
and 53.4942(b)-2 for 1 taxable year will not preclude it from satisfying 
such tests for a subsequent taxable year by the alternate method. If a 
foundation fails to satisfy the income test and either the assets, 
endowment, or support test for a particular taxable year under either 
the 3-out-of-4-year method or the aggregation method, it shall be 
treated as a nonoperating foundation for such taxable year and for all 
subsequent taxable years until it satisfies the tests set forth in 
Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 for a taxable year occurring 
after the taxable year in which it was treated as a nonoperating 
foundation.
    (b) New organizations--(1) In general. Except as provided in 
subparagraph (2) of this paragraph, an organization organized after 
December 31, 1969, will be treated as an operating foundation only if it 
has satisfied the tests set forth in Sec. Sec. 53.4942(b)-1 and 
53.4942(b)-2 for its first taxable year of existence. If an organization 
satisfies such tests for its 1st taxable year, it will be treated as an 
operating foundation from the beginning of such taxable year. If such is 
the case, the organization will be treated as an operating foundation 
for its 2d and 3d taxable years of existence only if it satisfies the 
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by the 
aggregation method for all such taxable years that it has been in 
existence.
    (2) Special rule. An organization organized after December 31, 1969, 
will be treated as an operating foundation prior to the end of its 1st 
taxable year if such organization has made a good faith determination 
that it is likely to satisfy the income test set forth in paragraph (a) 
of Sec. 53.4942(b)-1 and one of the tests set forth in Sec. 
53.4942(b)-2 for such 1st taxable year pursuant to subparagraph (1) of 
this paragraph. Such a ``good faith determination'' ordinarily will be 
considered as made where the determination is based on an affidavit or 
opinion of counsel of such organization that such requirements will be 
satisfied. Such an affidavit or opinion must set forth sufficient facts 
concerning the operations and support of such organization for the 
Commissioner to be able to determine that such organization is likely to 
satisfy such requirements. An organization which, pursuant to this 
subparagraph, has been treated as an operating foundation for its 1st 
taxable year, but actually fails to qualify as an operating foundation 
under subparagraph (1) of this paragraph for such taxable year, will be 
treated as a private foundation which is not an operating foundation as 
of the 1st day of its 2d taxable year for purposes of making any 
determination under the internal revenue laws with respect to such 
organization. The preceding sentence shall not apply if such 
organization establishes to the satisfaction of the Commissioner that it 
is likely to qualify as an operating foundation on the basis of its 2d, 
3d, and 4th taxable years. Thus, if such an organization fails to 
qualify as an operating foundation in its 2d, 3d, or 4th taxable year 
after having failed in its

[[Page 108]]

1st taxable year, it will be treated as a private foundation which is 
not an operating foundation as of the 1st day of such 2d, 3d, or 4th 
taxable year in which it fails to qualify as an operating foundation, 
except as otherwise provided by paragraph (d) of this section. Such 
status as a private foundation which is not an operating foundation will 
continue until such time as the organization is able to satisfy the 
tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 by either 
the 3-out-of-4-year method or the aggregation method. For the status of 
grants or contributions made to such an organization with respect to 
sections 170 and 4942, see paragraph (d) of this section.
    (c) Transitional rule for existing organizations. An organization 
organized before December 31, 1969 (including organizations deemed to be 
so organized by virtue of the principles of paragraph (e)(2) of Sec. 
53.4942(a)-2), but which is unable to satisfy the tests under Sec. Sec. 
53.4942(b)-1 and 53.4942(b)-2 for its first taxable year beginning after 
December 31, 1969 on the basis of its operations for taxable years prior 
to such taxable year by either the 3-out-of-4-year method or the 
aggregation method, will be treated as a new organization for purposes 
of paragraph (b) of this section only if:
    (1) The organization changes its methods of operation prior to its 
first taxable year beginning after December 31, 1972 to conform to the 
requirements of Sec. Sec. 53.4942(b)-1 and 53.4942 (b)-2;
    (2) The organization has made a good faith determination (within the 
meaning of paragraph (b) (2) of the section) that it is likely to 
satisfy the tests set forth in Sec. Sec. 53.4942(b)-1 and 53.4942(b)-2 
prior to its first taxable year beginning after December 31, 1972 on the 
basis of its income or assets held, received, or distributed during its 
taxable years beginning in 1970 through 1972; and
    (3) Such good faith determination is attached to the return the 
organization is required to file under section 6033 for its taxable year 
beginning in 1972.
    (d) Treatment of contributions--(1) In general. The status of grants 
or contributions made to an operating foundation with respect to 
sections 170 and 4942 will not be affected until notice of change of 
status of such organization is made to the public (such as by 
publication in the Internal Revenue Bulletin), unless the grant or 
contribution was made after:
    (i) The act or failure to act that resulted in the organization's 
inability to satisfy the requirements of Sec. Sec. 53.4942 (b)-1 and 
53.4942(b)-2, and the grantor or contributor was responsible for, or was 
aware of, such act or failure to act, or
    (ii) The grantor or contributor acquired knowledge that the 
Commissioner has given notice to such organization that it would be 
deleted from classification as an operating foundation.
    (2) Exception. For purposes of subparagraph (1) (i) of this 
paragraph, a grantor or contributor will not be considered to be 
responsible for, or aware of, the act or failure to act that resulted in 
the grantee organization's inability to satisfy the requirements of 
Sec. Sec. 53.4942 (b)-1 and 53.4942(b)-2 if such grantor or contributor 
has made his grant or contribution in reliance upon a written statement 
by the grantee organization that such grant or contribution would not 
result in the inability of such grantee organization to qualify as an 
operating foundation. Such a statement must be signed by a foundation 
manager (as defined in section 4946(b)) of the grantee organization and 
must set forth sufficient facts concerning the operations and support of 
such grantee organization to assure a reasonably prudent man that his 
grant or contribution will not result in the grantee organization's 
inability to qualify as an operating foundation.



               Subpart D_Taxes on Excess Business Holdings

    Authority: Secs. 4943 and 7805, Internal Revenue Code of 1954, 68A 
Stat. 917, 83 Stat. 507; 26 U.S.C. 4943, 7805.

    Source: T.D. 7496, 42 FR 46285, Sept. 15, 1977, unless otherwise 
noted.



Sec. 53.4943-1  General rule; purpose.

    Generally, under section 4943, the combined holdings of a private 
foundation and all disqualified persons (as defined in section 4946(a)) 
in any corporation conducting a business which is not substantially 
related (aside from the

[[Page 109]]

need of the foundation for income or funds or the use it makes of the 
profits derived) to the exempt purposes of the foundation are limited to 
20 percent of the voting stock in such corporation. In addition, the 
combined holdings of a private foundation and all disqualified persons 
in any unincorporated business (other than a sole proprietorship) which 
is not substantially related (aside from the need of the foundation for 
income or funds or the use it makes of the profits derived) to the 
exempt purposes of such foundation are limited to 20 percent of the 
beneficial or profits interest in such business. In the case of a sole 
proprietorship which is not substantially related (within the meaning of 
the preceding sentence), section 4943 provides that a private foundation 
shall have no permitted holdings. These general provisions are subject 
to a number of exceptions and special provisions which will be described 
in following sections.



Sec. 53.4943-2  Imposition of tax on excess business holdings of private foundations.

    (a) Imposition of initial tax--(1) In general--(i) Initial tax. 
Section 4943(a)(1) imposes an initial excise tax (the ``initial tax'') 
on the excess business holdings of a private foundation for each taxable 
year of the foundation which ends during the taxable period defined in 
section 4943(d)(2). The amount of such tax is equal to 5 percent of the 
total value of all the private foundation's excess business holdings in 
each of its business enterprises. In determining the value of the excess 
business holdings of the foundation subject to tax under section 4943, 
the rules set forth in Sec. Sec. 20.2031-1 through 20.2031-3 of this 
chapter (Estate Tax Regulations) shall apply.
    (ii) Disposition of certain excess business holdings within ninety 
days. In any case in which a private foundation acquires excess business 
holdings, other than as a result of a purchase by the foundation, the 
foundation shall not be subject to the taxes imposed by section 4943, 
but only if it disposes of an amount of its holdings so that it no 
longer has such excess business holdings within 90 days from the date on 
which it knows, or has reason to know, of the event which caused it to 
have such excess business holdings. Similarly, a private foundation 
shall not be subject to the taxes imposed by section 4943 because of its 
purchase of holdings where it did not know, or have reason to know of 
prior acquisitions by disqualified persons, but only if the foundation 
disposes of its excess holdings within the 90-day period described 
previously, and its purchase would not have created excess business 
holding but for such prior acquisitions by disqualified persons. In 
determining whether for purposes of this (ii) the foundation has 
disposed of such excess business holdings during such 90-day period, any 
disposition of holdings, by a disqualified person during such period 
shall be disregarded.
    (iii) Extension of ninety day period. The period described in 
paragraph (a)(1)(ii) of this section, during which no tax shall be 
imposed under section 4943, shall be extended to include the period 
during which a foundation is prevented by federal or state securities 
laws from disposing of such excess business holdings.
    (iv) Effect of disposition subject to material restrictions. If a 
private foundation disposes of an interest in a business enterprise but 
imposes any material restrictions or conditions that prevent the 
transferee from freely and effectively using or disposing of the 
transferred interest, then the transferor foundation will be treated as 
owning such interest until all such restrictions or conditions are 
eliminated (regardless of whether the transferee is treated for other 
purposes of the Code as owning such interest from the date of the 
transfer). However, a restriction or condition imposed in compliance 
with federal or state securities laws, or in accordance with the terms 
or conditions of the gift or bequest through which such interest was 
acquired by the foundation, shall not be considered a material 
restriction or condition imposed by a private foundation.
    (v) Foundation knowledge of acquisitions made by disqualified 
persons. (A) For purposes of paragraph (a)(1)(ii) of this section, 
whether a private foundation will be treated as knowing, or having 
reason to know, of the acquisition of holdings by a disqualified person

[[Page 110]]

will depend on the facts and circumstances of each case. Factors which 
will be considered relevant to a determination that a private foundation 
did not know or had no reason to know of an acquisition are: the fact 
that it did not discover acquisitions made by disqualified persons 
through the use of procedures reasonably calculated to discover such 
holdings; the diversity of foundation holdings; and the existence of 
large numbers of disqualified persons who have little or no contact with 
the foundation or its managers.
    (B) The provisions of paragraph (a)(1)(v)(A) of this section may be 
illustrated by the following example:

    Example. By the fifteenth day of the fifth month after the close of 
each taxable year, the F Foundation sends to each foundation manager, 
substantial contributor, person holding more than a 20% interest (as 
described in section 4946(a)(1)(C) in a substantial contributor, and 
foundation described in section 4946(a)(1)(H), a questionnaire asking 
such persons to list all holdings, actual or constructive, in each 
business enterprise in which F had holdings during the taxable year in 
excess of those permitted by the 2 percent de minimis rule of section 
4943(c)(2)(C). In preparing the list of such enterprises, F takes into 
account its constructive holdings only if, during the taxable year, F 
(along with all related foundations described in section 4946(a)(1)(H)) 
owned over 2% of the voting stock, profits interest or beneficial 
interest in the entity actually owning the holdings constructively held 
by F. The questionnaire asks each such person to list the holdings in 
such enterprises of any persons who, because of their relationship to 
such disqualified person, were themselves disqualified persons (i.e., 
members of the family (as defined in section 4946(d)), and any 
corporations, partnerships, trusts and estates described in section 
4946(a)(1) (E) through (G) in which such person, or members of his 
family, had an interest). The questionnaire asks that constructive 
holdings be listed only if, during the taxable year, the disqualified 
person owned over 2% of the voting stock, profits interest or beneficial 
interest in the entity actually owning the holdings constructively held 
by such person. (Thus a disqualified person owning less than 2% of a 
mutual fund is not required to list his attributed share of all the 
securities in the portfolio of the fund.) If no response to the 
questionnaire is received, the foundation seeks the information 
requested by the questionnaire by mailing a second (but not a third) 
questionnaire. If a questionnaire which is returned to the foundation 
indicates that certain information was unavailable to the person 
completing the questionnaire, the foundation seeks that information 
directly. For example, if a disqualified person indicates that he could 
not find out whether a corporation described in section 4946(a)(1)(E) 
had holdings in the enterprise listed in the questionnaire, the 
foundation seeks to obtain this information directly from the 
corporation by mailing it a questionnaire. In such a case F may be found 
not to have reason to know of the acquisition of holdings by a 
disqualified person.

    (vi) Holdings acquired other than by purchases. See section 
4943(c)(6) and Sec. 53.4943-6 for rules relating to the acquisition of 
certain holdings other than by purchase by the foundation or a 
disqualified person.
    (2) Special rules. In applying subparagraph (1) of this paragraph, 
the tax imposed by section 4943(a)(1):
    (i) Shall be imposed on the last day of the private foundation's 
taxable year, but
    (ii) The amount of such tax and the value of the excess business 
holdings subject to such tax shall be determined with respect to the 
foundation's holdings (based upon voting power, profits or beneficial 
interest, or value, whichever is applicable) in any business enterprise 
as of that day during the foundation's taxable year when the 
foundation's excess holdings in such enterprise were the greatest.

In applying subdivision (ii) of this subparagraph, if a foundation's 
excess business holdings in a business enterprise which constitute such 
foundation's greatest excess holdings in such enterprise for any taxable 
year are maintained for 2 or more days during such taxable year, the 
value of such excess holdings which is subject to tax under section 
4943(a)(1) shall be the greatest value of such excess holdings in such 
enterprise as of any day on which such greatest excess holdings are 
maintained during such taxable year.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Y is a private foundation reporting on a calendar year 
basis. On January 1, 1973, Y has 20 shares of common stock in 
corporation N, of which five shares constitute excess business holdings. 
On June 1, 1973, Y

[[Page 111]]

disposes of such five shares; however, because of additional 
acquisitions of N common stock on such date by disqualified persons with 
respect to Y, the remaining 15 shares of N common stock held by Y now 
constitute excess business holdings. There are no further acquisitions 
or dispositions of N common stock during 1973 by Y or its disqualified 
persons. Although Y's greatest holdings in N during 1973 are held 
between January 1, 1973, and May 31, 1973, Y's greatest excess holdings 
in N during 1973 are held between June 1, 1973, and December 31, 1973. 
Therefore, the tax specified in section 4943(a)(1) shall be computed on 
the basis of the greatest value of such greatest excess holdings as of 
any day between June 1 and December 31, 1973.
    Example 2. X is a private foundation reporting on a calendar year 
basis. On January 1, 1972, X has 100 shares of common stock in M 
corporation which are excess business holdings. On such date each share 
of M common stock has a fair market value of $100. On February 28, 1972, 
in an effort to dispose of such excess business holdings, X sells 70 
shares of M common stock for $120 per share (the fair market value of 
each share on such date) to A, an individual who is not a disqualified 
person within the meaning of section 4946(a). The value of $120 per 
share is the highest fair market value between January 1 and February 
28, 1972. X disposes of no more stock in M for the reminder of calendar 
year 1972. On December 31, 1972, the fair market value of each share of 
M common stock is $80. X calculates its tax on its excess business 
holdings in M for 1972 as follows:

100 shares of M common stock times $120 fair market value        $12,000
 per share as of Feb. 28, 1972..............................
$12,000 multiplied by rate of tax (percent).................           5
Amount of tax on X foundation's excess business holdings for        $600
 1972.......................................................
 

    Example 3. Assume the same facts as in Example (2) except that the 
sale of X to A occurs on January 7, 1973, when the fair market value of 
each share of M corporation common stock equals $70. A value of $100 per 
share is the highest fair market value of the M common stock between 
January 1 and January 7, 1973. On may 9, 1973, X for the first time has 
excess business holdings in N corporation in the form of 200 shares of N 
common stock. The value per share of N common stock on May 9, 1973, 
equals $200. X makes no disposition of the N common stock during 1973, 
and the value of each share of N common stock as of December 31, 1973 
equals $250 (the highest value of N common stock during 1973). X 
calculates its tax on its excess business holdings in both M and N for 
1973 as follows:

100 shares of M common stock times $100 fair market value        $10,000
 per share..................................................
  $250 fair market value per share..........................     $50,000
    Total...................................................     $60,000
                                                             -----------
    Total...................................................     $60,000
$60,000 multiplied by rate of tax (percent).................           5
Amount of tax on X foundation's excess business holdings for      $3,000
 1973.......................................................
 

    (b) Additional tax. In any case in which the initial tax is imposed 
under section 4943(a) with respect to the holdings of a private 
foundation in any business enterprise, if, at the close of the taxable 
period (as defined in section 4943(d)(2) and Sec. 53.4943-9) with 
respect to such holdings the foundation still has excess business 
holdings in such enterprise, there is imposed a tax under section 
4943(b) equal to 200 percent of the value of such excess holdings as of 
the last day of the taxable period.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4943-3  Determination of excess business holdings.

    (a) Excess business holdings--(1) In general. For purposes of 
section 4943, the term ``excess business holdings'' means, with respect 
to the holdings of any private foundation in any business enterprise (as 
described in section 4943(d)(4)), the amount of stock or other interest 
in the enterprise which, except as provided in Sec. 53.4943-2(a)(1), 
the foundation, or a disqualified person, would have to dispose of, or 
cause the disposition of, to a person other than a disqualified person 
(as defined in section 4946(a)) in order for the remaining holdings of 
the foundation in such enterprise to be permitted holdings (as defined 
in paragraphs (b) and (c) of this section). If a private foundation is 
required by section 4943 and the regulations thereunder to dispose of 
certain shares of a class of stock in a particular period of time and 
other shares of the same class of stock in a shorter period of time, any 
stock disposed of shall be charged first against those dispositions 
which must be made in such shorter period.
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Corporation X has outstanding 100 shares of voting stock, 
with each share entitling the holder thereof to one vote. F, a private 
foundation, possesses 20 shares of X voting stock representing 20 
percent of the voting power in X. Assume that the permitted

[[Page 112]]

holdings of F in X under paragraph (b)(1) of this section are 11 percent 
of the voting stock in X. F, therefore, possesses voting stock in X 
representing a percentage of voting stock in excess of the percentage 
permitted by such paragraph. Such excess percentage is 9 percent of the 
voting stock in X, determined by subtracting the percentage of voting 
stock representing the permitted holdings of F in X (i.e., 11 percent) 
from the percentage of voting stock held by F in X (I.E., 20 percent). 
(20%-11%=9%). The excess business holdings of F in X are an amount of 
voting stock representing such excess percentage, or 9 shares of X 
voting stock (9 percent of 100).

    (b) Permitted holdings in an incorporated business enterprise--(1) 
In general--(i) Permitted holdings defined. Except as otherwise provided 
in section 4943(c) (2) and (4), the permitted holdings of any private 
foundation in an incorporated business enterprise (including a real 
estate investment trust, as defined in section 856) are:
    (A) 20 percent of the voting stock in such enterprise reduced (but 
not below zero) by
    (B) The percentage of voting stock in such enterprise actually or 
constructively owned by all disqualified persons.
    (ii) Voting stock. For purposes of this section, the percentage of 
voting stock held by any person in a corporation is normally determined 
by reference to the power of stock to vote for the election of 
directors, with treasury stock and stock which is authorized but 
unissued being disregarded. Thus, for example, if a private foundation 
holds 20 percent of the shares of one class of stock in a corporation, 
which class is entitled to elect three directors, and such foundation 
holds no stock in the other class of stock, which is entitled to elect 
five directors, such foundation shall be treated as holding 7.5 percent 
of the voting stock because the class of stock it holds has 37.5 percent 
of such voting power, by reason of being able to elect three of the 
eight directors, and the foundation holds one-fifth of the shares of 
such class (20 percent of 37.5 percent is 7.5 percent). The fact that 
extraordinary corporate action (e.g., charter or by-law amendments) by a 
corporation may require the favorable vote of more than a majority of 
the directors, or of the outstanding voting stock, of such corporation 
shall not alter the determination of voting power of stock in such 
corporation in accordance with the two preceding sentences.
    (2) Nonvoting stock as permitted holdings--(i) In general. In 
addition to those holdings permitted by paragraph (b)(1) of this 
section, the permitted holdings of a private foundation in an 
incorporated business enterprise shall include any share of nonvoting 
stock in such enterprise held by the foundation in any case in which all 
disqualified persons hold, actually or constructively, no more than 20 
percent (35 percent where third persons have effective control as 
defined in paragraph (b)(3)(ii) of this section) of the voting stock in 
such enterprise. All equity interests which do not have voting power 
attributable to them shall, for purposes of section 4943, the classified 
as nonvoting stock. For this purpose, evidences of indebtedness 
(including convertible indebtedness), and warrants and other options or 
rights to acquire stock shall not be considered equity interests.
    (ii) Stock with contingent voting rights and convertible nonvoting 
stock. Stock carrying voting rights which will vest only when 
conditions, the occurrence of which are indeterminate, have been met, 
such as preferred stock which gains such voting rights only if no 
dividends are paid thereon, will be treated as nonvoting stock until the 
conditions have occurred which cause the voting rights to vest. When 
such rights vest, the stock will be treated as voting stock that was 
acquired other than by purchase, but only if the private foundation or 
disqualified persons had no control over whether the conditions would 
occur. Similarly, nonvoting stock which may be converted into voting 
stock will not be treated as voting stock until such conversion occurs. 
For special rules where stock is acquired other than by purchase, see 
section 4943(c)(6) and the regulations thereunder.
    (iii) Example. The provisions of this pararaph (2) may be 
illustrated by the following example:

    Example. Assume that F, a private foundation, holds 10 percent of 
the single class of voting stock of corporation X, and owns 20

[[Page 113]]

shares of nonvoting stock in X. Assume further that A and B, the only 
disqualified persons with respect to F, hold 10 percent of the voting 
stock of X. Under the provisions of paragraph (b)(1) of this section the 
10 percent of X voting stock held by F will be classified as permitted 
holdings of F in X since 20 percent less the percentage of voting stock 
held by A and B in X is 10 percent. In addition, under the provisions of 
this (2), the 20 shares of X nonvoting stock will qualify as permitted 
holdings of F in X since the percentage of voting stock held by A and B 
in X is no greater than 20 percent.

    (3) Thirty-five-percent rule where third person has effective 
control of enterprise--(i) In general. Except as provided in section 
4943(c)(4), paragraph (b)(1) of this section shall be applied by 
substituting 35 percent for 20 percent if:
    (A) The private foundation and all disqualified persons together do 
not hold, actually or constructively, more than 35 percent of the voting 
stock in the business enterprise, and
    (B) The foundation establishes to the satisfaction of the 
Commissioner that effective control (as defined in paragraph (b)(3)(ii) 
of this section) of the business enterprise is in one or more persons 
(other than the foundation itself) who are not disqualfied persons.
    (ii) ``Effective control'' defined. For purposes of this 
subparagraph, the term ``effective control'' means the possession, 
directly or indirectly, of the power to direct or cause the direction of 
the management and policies of a business enterprise, whether through 
the ownership of voting stock, the use of voting trusts, or contractual 
arrangements, or otherwise. It is the reality of control which is 
decisive and not its form or the means by which it is exercisable. Thus, 
where a minority interest held by individuals who are not disqualified 
persons has historically elected the majority of a corporation's 
directors, effective control is in the hands of those individuals.
    (4) Two percent de minimis rule--(i) In general. Under section 
4943(c)(2)(C), a private foundation is not treated as having excess 
business holdings in any incorporated business enterprise in which it 
(together with all other private foundations (including trusts described 
in section 4947(a)(2)) which are described in section 4946(a)(1)(H)) 
actually or constructively owns not more than 2 percent of the voting 
stock and not more than 2 percent in value of all outstanding shares of 
all classes of stock. If, however, the private foundation, together with 
all other private foundations which are described in section 
4946(a)(1)(H), actually or constructively owns more than 2 percent of 
either the voting stock or the value of the outstanding shares of all 
classes of stock in any incorporated business enterprise, all the stock 
in such business enterprise classified as excess business holding under 
section 4943 is treated as excess business holdings. For purposes of 
this paragraph, any stock owned by a private foundation which is treated 
as held by a disqualified person under section 4943(c)(4)(B), (5), or 
(6) shall be treated as actually owned by the private foundation. See 
paragraph (b)(1) of Sec. 53.4941(d)-4 for the determination of excess 
business holdings without regard to section 4943(c)(2)(C) for purposes 
of applying section 101(C)(2)(B) of the Tax Reform Act of 1969 (83 Stat. 
533).
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. F, a private foundation, owns 1 percent of the single 
class of voting stock and 1 percent in value of all the outstanding 
shares of all classes of stock in X corporation. No other private 
foundation described in section 4946(a)(1)(H) owns any stock in X. All 
of the stock owned by F in X would be excess business holdings under 
section 4943 (c)(1) if section 4943(c)(2)(C) were inapplicable. F owns 
no no other shares of stock in X. Since F owns more than 2 percent of 
the voting stock and no more than 2 percent in value of all outstanding 
shares of all classes of stock in X, under section 4943(c)(2)(C) none of 
the stock in X owned by F is treated as excess business holdings.
    Example 2. Assume the facts as stated in Example (1), except that F 
and T, a controlled private foundation under section 4946 (a)(1)(H), 
together own 1 percent of all the voting stock and 1 percent in value of 
all the outstanding shares of all classes of stock in X. All of the 
stock in X owned by F and T would be excess business holdings under 
section 4943(c)(1) if section 4943(c)(2)(C) were inapplicable. Since F 
and T together owned no more than 2 percent of the voting stock and no 
more than 2 percent in value of all outstanding shares of all classes of 
stock in X, under section 4943(c)(2)(C) none of the stock in X owned by 
either F or T is treated as excess business holdings.

[[Page 114]]

    Example 3. Assume the facts as stated in Example (1), except that F 
owns 3 percent of the voting stock in X, 2 percent of which is treated 
as held by P, a disqualified person of F, under section 4943(c)(4)(B). 
Under subdivision (i) of this subparagraph, the 2 percent of the stock 
in X owned by F which is treated as held by P under section 
4943(c)(4)(B) is treated as actually owned by F for purposes of section 
4943(c)(2)(C). Consequently, all of the X stock owned by F is treated as 
excess business holdings under section 4943(c)(2)(C). However, only 1 
percent of the stock in X is subject to tax under section 4943(a), since 
the other 2 percent is treated as owned by a disqualified person under 
section 4943(c)(4)(B) for purposes of determining the tax upon F under 
section 4943(a).

    (c) Permitted holdings in an unincorporated business enterprise--(1) 
In general. The permitted holdings of a private foundation in any 
business enterprise which is not incorporated shall, subject to the 
provisions of subparagraphs (2), (3), and (4) of this paragraph, be 
determined under the principles of paragraph (b) of this section.
    (2) Partnership or joint venture. In the case of a partnership 
(including a limited partnership) or joint venture. the terms ``profits 
interest'' and ``capital interest'' shall be substituted for ``voting 
stock'' and ``nonvoting stock,'' respectively, wherever those terms 
appear in paragraph (b) of this section. The interest in profits of such 
foundation (or such disqualified person) shall be determined in the same 
manner as its distributive share of partnership taxable income. See 
section 704(b) (relating to the determination of the distributive share 
by the income or loss ratio) and the regulations thereunder. In the 
absence of a provision in the partnership agreement, the capital 
interest of such foundation (or such disqualified person) in a 
partnership shall be determined on the basis of its interest in the 
assets of the partnership which would be distributable to such 
foundation (or such disqualified person) upon its withdrawal from the 
partnership, or upon liquidation of the partnership, whichever is the 
greater.
    (3) Sole proprietorship. For purposes of section 4943, a private 
foundation shall have no permitted holdings in a sole proprietorship. In 
the case of a transfer by a private foundation of a portion of a sole 
proprietorship, see paragraph (c)(2) of this section (relating to 
permitted holdings in partnerships). For the treatment of a private 
foundation's ownership of a sole proprietorship prior to May 26, 1969, 
see Sec. 53.4943-4.
    (4) Trusts and other unincorporated business enterprises--(i) In 
general. In the case of any unincorporated business enterprise which is 
not described in paragraph (c) (2) or (3) of this section, the term 
``beneficial interest'' shall be substitued for ``voting stock'' 
wherever the term appears in paragraph (b) of this section. Any and all 
references to nonvoting stock in paragraph (b) of this section shall be 
inapplicable with respect to any unincorporated business enterprise 
described in this subparagraph.
    (ii) Trusts. For purposes of section 4943, the beneficial interest 
of a private foundation or any disqualified person in a trust shall be 
the beneficial remainder interest of such foundation or person 
determined as provided in paragraph (b) of Sec. 53.4943-8.
    (iii) Other unincorporated business enterprises. For purposes of 
section 4943, the beneficial interest of a private foundation or any 
disqualified person in an unincorporated business enterprise (other than 
a trust or an enterprise described in paragraph (c) (2) or (3) of this 
section) includes any right to receive a portion of distributions of 
profits of such enterprise, and, if the portion of distributions is not 
fixed by an agreement among the participants, any right to receive a 
portion of the assets (if any) upon liquidation of the enterprise, 
except as a creditor or employee. For purposes of this subparagraph, a 
right to receive distributions of profits includes a right to receive 
any amount from such profits (other than as a creditor or employee), 
whether as a sum certain or as a portion of profits realized by the 
enterprise. Where there is no agreement fixing the rights of the 
participants in such enterprise, the interest of such foundation (or 
such disqualified person) in such enterprise shall be determined by 
dividing the amount of all equity investments or contributions to the 
capital of the enterprise made or obligated to be made by such 
foundation (or such disqualified person) by the amount of all equity 
investments or contributions to capital made or obligated to be

[[Page 115]]

made by all participants in the enterprise.
    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. Corporation X has outstanding 100 shares of voting stock, 
with each share entitling the holder thereof to one vote. Assume that F, 
a private foundation, possesses 30 shares of X voting stock, and that A 
and B, the only disqualified persons with respect to F, together own 10 
shares of X voting stock. The excess business holdings of F in X are 20 
shares of X voting stock, determined as follows:

(i) Determination of voting stock percentages
(a) Total number of outstanding votes in X..............             100
(b) Total number of votes in X held by F................              30
(c) Total number of votes in X held by A and B..........              10
(d) Percentage of voting stock in X held by F (item (b)               30
 divided by item (a)) (percent).........................
(e) Percentage of voting stock in X held by A and B                   10
 (item (c) divided by item (a)) (percent)...............
 
(ii) Determination of permitted holdings of voting stock
(a) Percentage of voting stock in X held by A and B                   10
 (percent)..............................................
(b) Permitted holdings of voting stock by F in X (20 pct              10
 less item (a)) (percent)...............................
 
(iii) Determination of excess business holdings
(a) Percentage of voting stock in X held by F (percent).              30
(b) Permitted holdings of voting stock by F in X                      10
 (percent)..............................................
(c) Item (a) less item (b) (percent)....................              20
(d) Excess business holdings of F in X (i.e., an amount               20
 of X voting stock representing a percentage of voting
 stock equivalent to that in item (c)) (shares).........
 
                              * * * * * * *
------------------------------------------------------------------------

    Example 2. F, a private foundation, is a partner in P partnership. 
In addition, A and B, the only disqualified persons with respect to F, 
are partners in P. The partnership agreement of P contains no provisions 
regarding the sharing of profits by, and the respective capital 
interests of, the partners.
    (i) assume that, under section 704(b), F's distributive share of P 
taxable income is determined to be 20 percent. In addition, assume that 
under such section, A and B are determined to have a 4-percent 
distributive share each of P taxable income. Accordingly, F holds a 20-
percent profits interest in P, and A and B hold an 8-percent profits 
interest in P. Assuming that the provisions of section 4943(c)(2)(B) do 
not apply, the permitted holdings of F in P are 12 percent of the 
profits interest in P, determined by subtracting the percentage of the 
profits interest held by A and B in P (i.e., 8 percent) from 20 percent. 
(20 percent-8 percent=12 percent.) F, therefore, holds a percentage of 
the profits interest in P in excess of the percentage permitted by Sec. 
53.4943-3(b)(1). The excess business holdings of F in P are a percentage 
of the profits interest in P equivalent to such excess percentage, or 8 
percent of the profits interest in P, determined by subtracting the 
permitted holdings of F in P (i.e., 12 percent) from the percentage of 
the profit interest held by F in P (i.e., 20 percent) (20 percent-12 
percent=8 percent.)
    (ii) Assume that, under the partnership agreement, F would be 
entitled to a distribution of 20 percent of P's assets upon F's 
withdrawal from P and to a distribution of 30 percent of P's assets upon 
the liquidation profits interest held by F in P (i.e., 20 percent) (20 
percent-12 percent=8 percent), of P. F, therefore, holds a 30-percent 
capital percentage of the assets of P distributable to F upon F's 
withdrawal from P, or the percentage of such assets distributable to F 
upon the liquidation of P. Since the percentage of the profits interest 
held by A and B in P is less than 20 percent, such 30-percent capital 
interest will be included in the permitted holdings of F in P.



Sec. 53.4943-4  Present holdings.

    (a) Introduction--(1) Section 4943 (c)(4) in general. (i) Paragraph 
(4) of section 4943(c) prescribes transition rules for a private 
foundation which, but for such paragraph, would have excess business 
holdings on May 26, 1969. Section 4943(c)(4) provides such a foundation 
with protection from the initial tax on excess business holdings in two 
ways. First, the entire interest of such a foundation in any business 
enterprise in which such a foundation, but for section 4943(c)(4), would 
have had excess business holdings on May 26, 1969, is treated under 
section 4943(c)(4)(B) as held by disqualified persons for a certain 
period of time (the ``first phase''). The effect of such treatment is to 
prevent a private foundation from being subject to the initial tax with 
respect to its May 26, 1969, interest during the first phase holding 
period and also to prevent the foundation from purchasing any additional 
business holdings in such business enterprise during

[[Page 116]]

such period (unless the combined holdings of the foundation and all 
disqualified persons fall below the 20 percent (or 35 percent, if 
applicable) figure prescribed by section 4943(c)(2)). Second, section 
4943(c)(4)(A)(i) initially increases the percentage of permitted 
holdings of such a foundation to a percentage equal to the difference 
between:
    (A) The percentage of combined holdings of the foundation and all 
disqualified persons in such business enterprise on May 26, 1969 
(subject to a 50 percent maximum), and
    (B) The percentage of holdings of all disqualified persons.

The percentage referred to in paragraph (a)(1)(i)(A) of this section is 
referred to in this section as the ``substituted level''. This 
``substituted level'' is then reduced by the ``downward ratchet rule'' 
prescribed by section 4943(c)(4)(A)(ii) and paragraph (d)(3) of this 
section for certain dispositions by such foundation or by disqualified 
persons. The primary purpose of the substituted level is to indicate 
what the permitted holdings in such business enterprise will be 
immediately after the expiration of the first phase holding period. 
Thereafter, the permitted holdings of a private foundation itself are 
further limited to a maximum 25 percent interest in such business 
enterprise by section 4943(c)(4)(D) as soon as the combined holdings of 
all disqualified persons in such business enterprise exceed 2 percent 
(of the voting stock). If the combined holdings of all disqualified 
persons at no time exceed 2 percent (of the voting stock) during the 15 
years following the first phase (the ``second phase''), then the 
substituted level is reduced to a 35 percent maximum after the second 
phase.
    (ii) Paragraph (a)(1)(i) of this section may be illustrated by the 
following example:

    Example. On May 26, 1969, private foundation P held a 5 percent 
interest in corporation X (voting stock and value). On such date 
disqualified persons held a 16 percent interest in X (voting stock and 
value). Assume that except for section 4943(c)(4), P would have had a 1 
percent interest in X which would have consitituted excess business 
holdings. Therefore, section 4943(c)(4)(B) applies and P's 5 percent 
interest in X is treated as held by a disqualified person during the 10-
year period beginning May 26, 1969. Since the entire 21 percent held by 
P and disqualified persons is now treated as held by disqualified 
persons, P's substituted level is 21 percent and its permitted holdings 
are zero (21%-21%). However, P has no excess business holdings in X, 
because during the 10-year period P is not treated as holding such 
interest. The only change in the interest in X occurs on January 2, 
1972, when P disposes of 2 percent of its interest in X to A, an 
unrelated person. Since the interest held by P and all disqualified 
persons (21%-2%=19%) has decreased below 20 percent, P's substituted 
level is reduced to 20 percent and its permitted holdings are 1 percent 
(20%-19%) on such date. Therefore, if the other interests in X do not 
change, P will not have excess business holdings if P purchases no more 
than an additional 1 percent interest in X.

    (2) Interaction of provisions of section 4943(c) (4), (5), and (6). 
During the first phase, a private foundation may acquire additional 
interests in a business enterprise, other than by purchase, which are 
entitled to be treated as held by disqualified persons for varying 
holding periods under section 4943(c) (5) or (6) (relating respectively 
to certain holdings aquired pursuant to the terms of a trust or will in 
effect on May 26, 1969, and to the 5-year period to dispose of certain 
gifts, bequests, etc.). In any case holdings which the private 
foundation disposes of shall be charged first against those holdings 
which it must dispose of in the shortest period in order to avoid the 
initial tax thereon. Further, acquisions of a private foundation under a 
pre-May 27, 1969, will or trust described in section 4943(3)(5) are 
treated in a manner similar to the treatment of interests actually held 
by a private foundation on May 26, 1969. See Sec. Sec. 53.4943-5 and 
53.4943-6.
    (b) Present holdings in general. (1) Section 4943(c)(4)(B) provides 
that any interest in a business enterprise held by a private foundation 
on May 26, 1969, if the foundation on such date has excess business 
holdings (determined without regard to section 4943(c)(4)), shall (while 
held by the foundation) be treated as held by a disqualified person 
during a first phase. Therefore, no interest of a private foundation 
shall be treated as held by a disqualified person under section 
4943(c)(4)(B) and this section unless:

[[Page 117]]

    (i) The private foundation was an entity (not including a revocable 
trust) in existence on May 26, 1969, even though it was not then treated 
as a private foundation under section 509 or section 4947;
    (ii) Such interest was actually or constructively owned by such 
entity on such date; and
    (iii) Without regard to section 4943(c)(4) such entitly had on such 
date an interest (considered in connection with the interests actually 
or constructively owned by all disqualified persons with respect to such 
entity on that date in the same business enterprise, determined as if 
the entity were then a private foundation) which exceeded the permitted 
holdings prescribed by section 4943(c) (2) or (3).

(See, however, section 4943(c)(5) and Sec. 53.4943-5 for similar 
treatment for certain interests acquired by a private foundation under 
the terms of a trust or a will which were in effect on May 26, 1969.) If 
a private foundation owns an interest described by section 
4943(c)(4)(B), then the length of the first phase for such an interest 
is prescribed by paragraph (c) of this section and shall not be affected 
by any interest acquired by the private foundation or any disqualified 
person in such business enterprise after May 26, 1969. In addition, the 
amount of permitted holdings in such business enterprise is prescribed 
by paragraph (d) of this section. An interest constructively held by a 
private foundation (or a disqualified person) on May 26, 1969, shall not 
cease to be an interest to which section 4943(c)(4) applies merely 
because it is later distributed to such foundation (or to such 
disqualified person). Nor shall an interest directly held by a private 
foundation (or to such disqualified person) on May 26, 1969, cease to be 
treated as an interest to which section 4943(c)(4) applies to the extent 
it remains actually or constructively held by such foundation (or such 
disqualified person) upon transfer of such interest, such as upon the 
incorporation of a sole proprietorship.
    (2) The provision of this paragraph may be illustrated by the 
following example:

    Example. A, a nonprofit research organization described in section 
501(c)(3), was organized in 1966. On May 26, 1969, A held 50 percent of 
the stock of corporation B. For its taxable years 1970, 1971, and 1972, 
A is classified as an organization described in section 509(a)(2). 
However, for 1973 and subsequent years, A fails to satisfy the gross 
investment income limitation of section 509(a)(2)(B), and is thus 
classified as a private foundation. In such a case, section 4943(c)(4) 
applies, and a disqualified person shall be treated as holding A's stock 
in B during a first phase that begins on May 26, 1969.

    (c) First Phase holding periods--(1) In general. If, on May 26, 
1969, a private foundation has excess business holdings in any business 
enterprise (determined with regard to the 20 or 35 percent permitted 
holdings of section 4943(c)(2)), then all interest which such foundation 
holds, actually or constructively, in such enterprise on May 26, 1969, 
shall (while held by such foundation) be deemed held by a disqualified 
person during the following periods:
    (i) The 20-year period beginning on May 26, 1969, if the private 
foundation holds, actually or constructively, more than 95 percent of 
the voting stock (or more than a 95 percent profits or beneficial 
interest in the case of an unincorporated enterprise) in such enterprise 
on such date;
    (ii) Except as provided in paragraph (c)(1)(i) of this section, the 
15-year period beginning on May 26, 1969, if the private foundation and 
all disqualified persons hold, actually or constructively on such date 
more than 75 percent of the voting stock (or more than a 75 percent 
profits or beneficial interest in the case of any unincorporated 
enterprise) or 75 percent of the value of all outstanding shares of all 
classes of stock in such enterprise (or more than a 75 percent profits 
and capital interest in the case of a partnership or joint venture); or
    (iii) The 10-year period beginning on May 26, 1969, in any case not 
described in paragraph (c)(1) (i) or (ii) of this section.

The 20-year, 15-year, or 10-year period described in this subdivision 
(whichever applies) shall, for purposes of section 4943 and this 
section, be known as the ``first phase.''
    (2) Sole proprietorships. The 20-year period described in paragraph 
(c)(1) of this section shall apply with respect to

[[Page 118]]

any interest which a private foundation holds in a sole proprietorship 
on May 26, 1969. See paragraph (b) of this section for the effect of 
converting such an enterprise to a corporate, partnership, or other 
form.
    (3) Suspension of first-phase periods. The 20-year, 15-year, or 10-
year period described in paragraph (c)(1) of this section shall be 
suspended during the dependency of any judicial proceeding which is 
brought and diligently litigated by the private foundation and which is 
necessary to reform, or to excuse the foundation from compliance with, 
its governing instrument or any other instrument (as in effect on May 
26, 1969) in order to allow disposition of any excess business holdings 
held by the foundation on May 26, 1969.
    (4) Election to shorten the period during which certain holdings of 
private foundations are treated as held by disqualified persons. If, on 
May 26, 1969, the combined holdings of a private foundation and all 
disqualified persons in any one business enterprise are such as to make 
applicable the 15-year period referred to in paragraph (c)(1)(ii) of 
this section, and if, on such date, the foundation's holdings do not 
exceed 95 percent of the voting stock in such enterprise, then such 15-
year period is shortened to the 10-year period referred to in paragraph 
(c)(1)(iii), if at any time before January 1, 1971, one or more 
individuals:
    (i) Who are substantial contributors (as described in section 
507(d)(2)), or members of the family within the meaning of section 
4946(d) of one or more substantial contributors, to such private 
foundation, and
    (ii) Who on May 26, 1969, held in the aggregate more than 15 percent 
of the voting stock in the enterprise, made an election in the manner 
described in 26 CFR 143.6 (rev. as of Apr. 1, 1974).
    (5) Examples. The provisions of this paragraph (c) may be 
illustrated by the following examples:

    Example 1. Assume that F, a private foundation, owns, on May 26, 
1969, 50 shares of voting stock in corporation X respresenting 50 
percent of the voting power in X and 25 percent of the value of all 
outstanding shares of all classes of stock in X. Assume further that A 
and B, the only disqualified persons with respect to F, own five shares 
each of voting stock in X on such date. The 10 shares of voting stock in 
X owned by A and B together represent 10 percent of the voting power in 
X and 5 percent of the value of all outstanding shares of all classes of 
stock in X. Under the provisions of Sec. 53.4943-3, the excess business 
holdings of F, in X (determined without regard to section 4943(c)(4)) as 
of such date are, therefore, 40 percent of X voting stock. Accordingly, 
since the combined holdings of F, A, and B in X are, on such date, less 
than 75 percent of the voting stock in X and less than 75 percent of the 
value of all outstanding shares of all classes of stock in X, under the 
provisions of section 4943(c)(4)(B)(iii), all holdings of F in X (i.e., 
50 percent of X voting stock) will be treated as held by a disqualified 
person through May 25, 1979.
    Example 2. Assume the facts as stated in Example (1), except that F, 
on December 15, 1969, purchases an additional 10 shares of voting stock 
in X representing 10 percent of X voting power. Assume, further, that 
there were no other transactions in the stock in X during 1969. While 
the 50 percent of X voting stock held by F on May 26, 1969, will be 
deemed held by a disqualified person through May 25, 1979, the 
additional 10 shares of X voting stock acquired by purchase by F on 
December 15, 1969, will no be deemed to be so held. Accordingly, since, 
under the provisions of Sec. 53.4943-3, such 10 shares represent excess 
business holding of F in X, such 10 shares will be subject to the 
imposition of tax under the provisions of section 4943(a).
    Example 3. Assume the facts as stated in Example (1), except that F, 
on December 15, 1971 acquires an additional 10 shares of voting stock in 
X (representing 10 percent of X voting power) under the terms of a will 
which was executed before May 26, 1969, to which section 4943(c)(5) 
applies. While the 50 percent of X voting stock held by F on May 26, 
1969, will be deemed held by a disqualified person through May 25, 1979, 
the additional 10 percent of X voting stock acquired by F on December 
15, 1971, will, under the provisions of section 4943(c)(5), be deemed 
held by a disqualified person through December 14, 1981. See Sec. 
53.4943-5.
    Example 4. Assume that F, a private foundation, owns on May 26, 
1969, 50 shares of voting stock in corporation Y representing 50 percent 
of the voting power in Y. Assume further that C and D, the only 
disqualified persons with respect to F, own on such date 15 shares each 
of Y voting stock and that the 30 shares of Y voting stock owned by C 
and D together represent 30 percent of the voting power in Y. Under the 
provisions of Sec. 53.4943-3 the excess business holdings of F in Y 
(determined without regard to section 4943(c)(4)) as of such date are, 
therefore, 50 percent of Y voting stock. Accordingly, since the combined 
holdings of F, C, and D in Y represent, on such date, more than 75 
percent of the voting stock in Y, under the provisions of section 
4943(c)(4)(B)(ii), all holdings of F in Y

[[Page 119]]

(i.e., 50 percent of Y voting stock will be treated as held by a 
disqualified person through May 25, 1984.
    Example 5. M, a private foundation, owns on May 26, 1969, sole 
proprietorship S. Since, under the provisions of Sec. 53.5954-3, M's 
ownership of S constitutes excess business holdings (determined without 
regard to section 4943(c)(4) as of May 26, 1969, and since M's interest 
in S is greater than 95 percent on such date, under the provisions of 
this paragraph a disqualified person will be treated as the owner of S 
for the 20-year period beginning on such date. If S is later 
incorporated, that percentage of the interest in S retained by M, even 
though less than a 95-percent interest, shall continue to be treated as 
held by a disqualified person through May 25, 1989.
    Example 6. A and B, individuals, together own on May 26, 1969, 40 
shares of voting stock in corporation X representng 40 percent of the 
voting power in X and 20 percent of the value of all outstanding shares 
of all classes of stock in X. A and B are both disqualified persons with 
respect to F, a private foundation, which owns no stock in X on May 26, 
1969. On January 1, 1973, A and B donate the 40 shares of X voting stock 
held by them to F. Since F had no excess business holdings on May 26, 
1969, section 4943(c)(4) does not apply. See however, section 4943(c)(6) 
and Sec. 53.4943-6.
    Example 7. Assume the facts as stated in Example (6), except that F, 
on May 26, 1969, owns 50 shares of voting stock in X, representing 50 
percent of the voting power in X and 25 percent of the value of all 
outstanding shares of all classes of stock in X. Under the provisions of 
this paragraph, the 50 shares of X voting stock held by F on May 26, 
1969 shall be treated in accordance with the provisions of section 
4943(c)(4), while the 40 shares of X voting stock acquired by F on 
January 1, 1973 shall be treated in accordance with the provisions of 
section 4943(c)(6). See Sec. 53.4943-6.

    (d) Permitted holdings under section 4943(c)(4)--(1) In general. The 
permitted holdings of a private foundation to which section 4943 (c)(4) 
applies in a business enterprise shall be as follows:
    (i) The excess of the substituted combined voting level over the 
disqualified person voting level, and separately,
    (ii) The excess of the substituted combined value level over the 
disqualified person value level.
    (2) Definitions. For purposes of paragraph (d) of this section:
    (i) The term disqualified person voting level on any given date 
means the percentage of voting stock held by all disqualified persons 
together on such date (including stock deemed held by such a person by 
reason of section 4943(c)(4), (5), or (6)).
    (ii) The term disqualified person value level on any given date 
means the percentage of the total value of all outstanding shares of all 
classes of stock in a business enterprise held by all disqualified 
persons together on such date (including stock deemed held by such a 
person by reason of section 4943(c)(4), (5), or (6)).
    (iii) The term foundation voting level prior to the second phase is 
equal to zero. After the first phase, such term on any given date means 
the lowest percentage of voting stock held by a private foundation 
(without regard to section 4943(c)(4)(B)) in a business enterprise on 
May 26, 1969, and at all times thereafter up to such date. See section 
4943(c)(5) and Sec. 53.4943-5 for the effect of the interests acquired 
pursuant to the terms of certain wills or trusts in effect on May 26, 
1969.
    (iv) The term foundation value level prior to the second phase is 
equal to zero. After the first phase, such term on any given date means 
the lowest percentage of the total value of all outstanding shares of 
all classes of stock held by a private foundation (without regard to 
section 4943(c)(4)(B)) in a business enterprise on May 26, 1969, and at 
all times thereafter up to such date. See section 4943(c)(5) and Sec. 
53.4943-5 for the effect of interests acquired pursuant to the terms of 
certain wills or trusts in effect on May 26, 1969.
    (v) The term substituted combined voting level means the lowest 
percentage to which the sum of the foundation voting level plus the 
disqualified person voting level has been reduced since May 26, 1969, by 
paragraph (d)(4) of this section to the following modifications (the 
``downward ratchet rule''), subject;
    (A) In no event shall such substituted level exceed 50 percent; and
    (B) Such substituted level shall be increased (but not above 50 
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for 
certain interests acquired by such foundation pursuant to the terms of a 
will or trust in effect on May 26, 1969.
    (vi) The term substituted combined value level means the lowest 
percentage to which the sum of the foundation value level plus the 
disqualified person

[[Page 120]]

value level has been reduced since May 26, 1969, by paragraph (d)(4) of 
this section (the ``downward ratchet rule''), subject to the following 
modifications:
    (A) In no event shall such substituted level exceed 50 percent; and
    (B) Such substituted level shall be increased (but not above 50 
percent) in accordance with section 4943(c)(5) and Sec. 53.4943-5 for 
certain interests acquired by such foundation pursuant to the terms of a 
will or trust in effect on May 26, 1969.
    (vii) In the case of an interest in a partnership or joint venture, 
definitions (i) through (iv) of this subparagraph shall be applied by 
substituting ``profit interests'' for ``voting stock'' and ``all 
partnership interests'' for ``all outstanding shares of all classes of 
stock.''
    (viii) In the case of an interest in a business enterprise other 
than a corporation, partnership or joint venture, definitions (i) 
through (iv) of this subparagraph shall be applied by substituting 
``beneficial remainder interests'' for ``voting stock'' and ``all 
beneficial remainder interests'' and ``all outstanding shares of all 
classes of stock.''
    (ix) Each level defined in paragaph (d)(2)(iii), (iv) and (v) and 
(vi) as of any date shall be carried over to the subsequent date subject 
to any adjustments prescribed for such level.
    (3) Permitted holdings--First phase. Since during the first phase 
the substituted combined voting level generally does not exceed the 
disqualified person voting level, and the substituted combined value 
level generally does not exceed the disqualified person value level, the 
permitted holdings during the first phase are generally equal to zero. 
The permitted holdings during the first phase exceed zero only where the 
20 percent (or 35 percent) limitation on the downward ratchet rule 
contained in paragraph (d)(4)(ii)(B) of this section applies.
    (4) Downward ratchet rule--(i) In general. Except as provided in 
paragraph (d)(4)(ii) of this section and section 4943(c)(5):
    (A) Scope of rule. In general, when the percentage of the holdings 
in a business enterprise held by a private foundation and all 
disqualified persons together to which section 4943(c)(4) applies 
decreases, or when the percentage of the holdings of the private 
foundation alone in such business enterprise decreases, such holdings 
may not be increased (except as provided under section 4943(c) (5) or 
(6)). This so-called ``downward ratchet rule'' is designed to prevent 
the private foundation from purchasing additional holdings in the 
business enterprise until the substituted combined voting level reduced 
to the 20-percent (or 35 percent) figure prescribed by section 
4943(c)(2).
    (B) Levels affected. Under the downward ratchet rule any decrease 
after May 26, 1969, in the percentage of holdings comprising either the 
substituted combined voting level, the substituted combined value level, 
the foundation voting level or the foundation value level shall cause 
the respective level to be decreased to such decreased percentage for 
purposes of determining the foundation's permitted holdings.
    (C) Implementation of reductions. Thus, if at any time the sum of 
the foundation voting level and the disqualified peson voting level is 
less than the immediately preceding substituted combined voting level, 
the substituted level shall be decreased so that it equals such sum. For 
example, if on May 26, 1969, a foundation and all disqualified persons 
together have holdings in a business enterprise equal to 50 percent, on 
such date the substituted combined voting level and the disqualified 
person voting level equal 50 percent (since such holdings of the 
foundation are treated as held by a disqualified person). If the private 
foundation or a disqualified person on May 27, 1969, sold 2 percent of 
such holdings to a nondisqualified person, the disqualified person 
voting level would be decreased to 48 percent (50%-2%), causing the 
substituted combined voting level to be decreased to 48 percent. As a 
further example, assume that on May 26, 1969, a foundation and all 
disqualified persons together have holdings in a business enterprise 
equal to 50 percent, and when the first phase expires on May 26, 1979, 
the substituted combined voting level is still 50 percent, the 
foundation voting level is 10 percent, and the disqualified person 
voting level is 40 percent. If a disqualified person there-

[[Page 121]]

after sells 2 percent to a nondisqualified person so that the sum of the 
disqualified person voting level (40%-2%=38%) and the foundation voting 
level (10%) equals 48 percent (38%+10%), then the substituted combined 
voting level is decreased to 48 percent. Similarly, if at any time the 
sum of the foundation value level and the disqualified person value 
level is less than the immediately preceding substituted combined value 
level, the substituted combined value level shall be decreased so that 
it equals such sum.
    (D) Restrictions on increases in levels. In addition, none of the 
four levels referred to in paragraph (d)(4)(i)(B) of this section may be 
adjusted upward to reflect any increase in the holdings comprising such 
level, except as provided in section 4943(c)(5) and Sec. 53.4943-5. As 
a result, any transfer of May 26, 1969, holdings from a disqualified 
person to a private foundation shall not increase the foundation voting 
level or the foundation value level (unless the transfer qualifies under 
section 4943(c)(5)), and thus may reduce the substituted combined value 
level (and where appropriate, the substituted combined voting level). 
Thus, in the last preceding example, if the disqualified person, instead 
of selling the 2 percent interest to a nondisqualified person, had sold 
such interest to the foundation, the substituted combined voting level 
would still be reduced to 48 percent, since the disqualified person 
voting level would be reduced by 2 percent (to 38%) but the foundation 
voting level would not be increased by 2 percent (remaining at 10%). 
However, any transfer of May 26, 1969, holdings from a private 
foundation to a disqualified person under section 101(1)(2)(B) of the 
Tax Reform Act of 1969, shall reduce the foundation value level (and, 
where appropriate, the foundation voting level), but will not reduce the 
substituted combined value level or the subsituted combined voting 
level. The disqualified person voting level and disqualified person 
value level are correspondingly increased, not being limited to interest 
held since May 26, 1969. In addition, a transfer of May 26, 1969, 
holdings from one disqualified person to another, for example, by 
bequest, shall not reduce the substituted combined voting level nor the 
substituted combined value level.
    (ii) Exceptions--(A) One percent de minimus rule. If after May 26, 
1969, there are one or more decreases in the holdings comprising any of 
the four levels referred to in paragraph (d)(4)(i)(B) of this section 
during any taxable year of a private foundation, and if such decreases 
are attributable to issuances of stock (or such issuances coupled with 
redemptions), then, unless the aggregate of such decreases equals or 
exceeds 1 percent, the determination of whether there is a decrease in 
such level for purposes of this paragraph (d)(4) shall be made only at 
the close of such taxable year. If, however, the aggregate of such 
decreases equals or exceeds 1 percent, such level shall be decreased at 
that time as if the previous sentence has never applied.
    (B) Twenty percent (or 35 percent) floor. In no event shall the 
downward rachet rule contained in paragraph (d)(4)(i) of this section 
decrease the substituted combined voting level or the substituted 
combined value level below 20 percent, or, for purposes of section 
4943(c)(2)(B), below 35 percent.
    (iii) Special rules--(A) Change of foundation managers. In the case 
of a foundation manager (as defined in section 4946(b)) who on May 26, 
1969, owns holdings in a business enterprise and who is replaced by 
another foundation manager, the decrease in the substituted combined 
voting or value levels shall be limited to the excess, if any, of the 
departing foundation manager's holdings over his successor's holdings.
    (B) Termination of private foundation status under section 507. If 
an organization gives the notification described in section 
507(b)(1)(B)(ii) of the commencement of a 60-month termination period 
and fails to meet the requirements of section 509(a)(1), (2) or (3) for 
the entire period, then such organization will be treated as a private 
foundation during the entire 60-month period for purposes of this 
paragraph (d)(4) and section 4946(a)(1)(H). For example, X, a private 
foundation gives notification of the commencement of a 60-month 
termination commencing on

[[Page 122]]

January 1, 1972. X and Y, another private foundation, are effectively 
controlled by the same persons within the meaning of section 
4946(a)(1)(H). X and Y hold 25 percent each of the voting stock of Z 
corporation on May 26, 1969, so that the substituted combined voting 
level for X or Y is 50 percent on such date. If X meets the requirements 
of section 509(a) (1), (2), or (3) for the entire 60-month period, 
section 4946(a)(1)(H) is inapplicable to X, and, under the downward 
ratchet rule, the substituted combined voting level for Y is decreased 
by 25 percent. On the other hand, if X meets the requirements of section 
509(a)(2) for its taxable years 1972 and 1973, but fails to meet the 
requirements of section 509(a) (1), (2), or (3) in 1974, 1975, and 1976, 
then solely for purposes of section 4943(c)(4)(A)(ii) and this paragraph 
(d)(4), X will be treated as a disqualified person with respect to Y, 
and Y will be treated as a disqualified person with respect to X, for 
taxable years 1972 through 1976 pursuant to section 4946(a)(1)(H). Thus, 
for purposes of section 4943(c)(4)(A)(ii) the substituted combined 
voting level for X or Y will not be decreased by reason of the fact that 
X was attempting to terminate under section 507(b)(1)(B), and assuming 
no other transportations, such level; will remain at 50 percent.
    (iv) Examples. The provisions of this paragraph (d)(4) may be 
illustrated by the following examples:

    Example 1. F, a private foundation, owns on May 26, 1969, 50 shares 
of voting stock in corporation X representing to 50 percent of the 
voting stock in X and 25 percent of the value of all outstanding shares 
of all classes of stock in X. A and B, the only disqualified persons 
with respect to F, together own, on such date, 2 shares of voting stock 
in X representing 2 percent of the voting shock in X and 1 percent of 
the value of all outstanding shares of all classes of stock in X. In 
addition, on such date, F owns 30 shares of nonvoting stock in X, 
representing 30 percent of the value of all outstanding shares of all 
classes of stock in X, and A and B together own 15 shares of nonvoting 
stock in X representing 15 percent of the value of all outstanding 
shares of classes of stock in X. The provisions of section 
4943(c)(4)(B)(iii) apply and during the 10-year period beginning on May 
26, 1969, a disqualified person is deemed to hold all interests of F in 
X. Assume that on February 1, 1972, F sells to C, unrelated in 
individual, 12 shares of voting stock in X representing 12 percent of 
the voting stock in X and 6 percent of the value of all outstanding 
shares of all classes of stock in X.
    (i) Beginning on May 26, 1969, the disqualified person voting level 
is 52 percent, the foundation voting level is zero, and the substituted 
combined voting level is 50 percent; the disqualified person value level 
is 71 percent, the foundation value level is zero, and the substituted 
combined value level is 50 percent.
    (ii) Beginning on February 1, 1972, the disqualified person voting 
level is 40 percent (52%-12%), the foundation voting level is zero, and 
the substituted combined voting level is 40 percent; the disqualified 
person value level is 65 percent (71%-6%), the foundation value level is 
zero and the substituted combined value level is 50 percent.
    Example 2. F, a private foundation on the calendar year basis, 
holds, on May 26, 1969, 30 percent of the voting stock in corporation Y. 
C and D, the only disqualified persons with respect to F, together hold, 
on such date, 10 percent of the voting stock in Y. The provisions of 
section 4943(c)(4)(B)(iii) apply with respect to F, and disqualified 
persons are deemed to hold all interests of F in Y for the 10-year 
period beginning on May 26, 1969, so that the substituted combined 
voting level as of such date is 40 percent. On February 1, 1973, a stock 
issuance by Y causes the combined holdings of voting power by F, C, and 
D in Y to decrease by 0.3 percent. on June 1, 1973, another such 
issuance causes such combined holdings to decrease by 0.5 percent. In 
September 1, 1973, an unrelated stock redemption by Y causes such 
combined holdings to increase by 0.4 percent. Under this paragraph the 
determination whether there is a decrease in the substituted combined 
voting level for purposes of the downward ratchet rule shall not be made 
before January 1, 1974, since the aggregate of the decreases occurring 
on February 1 and June 1 of 1973 is less than 1 percent (0.3%+0.5%). 
Therefore, the substituted combined voting level as of January 1, 1974, 
is 39.6 percent (40%-[(0.3%+0.5%)-0.4%].)
    Example 3. Assume the facts as stated in Example (2), except that, 
on October 1, 1973, a stock issuance by Y causes the combined holdings 
of voting power by F, C, and D in Y to decrease by 0.3 percent. Since 
the aggregate of the decreases occurring on February 1, June 1, and 
October 1 of 1973 exceeds 1 percent, the determination whether there is 
a decrease in the substituted combined voting level shall be made as of 
October 1, 1973. At that time the substituted combined voting level 
shall be reduced to 39.2 percent (40%-0.3%-0.5%), the lowest actual 
combined holdings during the period that the de minimis rule was in 
effect.

    (5) Permitted holdings--Second phase--(i) In general. For purposes 
of section

[[Page 123]]

4943 and this section, the term ``second phase'' means the 15-year 
period immediately following the first phase. Upon the expiration of the 
first phase with respect to an interest to which section 4943(c)(4) 
applies, such interest shall no longer be treated as held by a 
disqualified person under section 4943(c)(4)(B). During the second 
phase, the manner of determining the permitted holdings of a private 
foundation to which section 4943(c)(4) applies shall be the same as 
applicable to the first phase, except that a 25 percent maximum shall 
apply under certain conditions specified in paragraph (d)(5)(ii) of this 
section. For these purposes the substituted combined voting level and 
the substituted combined value level in effect for the foundation at the 
end of the first phase shall be carried over to the second phase. The 
substituted levels are carried over because although there is a decrease 
in the disqualified person levels (since holdings are no longer treated 
as held by disqualified persons under section 4943(c)(4)(B)), a 
corresponding increase in the foundation levels occurs. For example, if 
a private foundation on May 26, 1969, held 10 percent of the voting 
stock in a corporation and disqualified persons held 40 percent of the 
voting stock, both the disqualified person voting level and the 
substituted combined voting level equal 50 percent (10%+40%). Assuming 
no transactions during the first phase, on May 26, 1979, the 
disqualified person voting level would be decreased to 40 percent (50%-
10%), but the foundation voting level would be increased to 10 percent 
so that the substituted combined voting level would remain at 50 
percent. In addition, the downward ratchet rule of paragraph (d)(4) of 
this section shall continue to apply, to prevent the foundation and 
disqualified persons from purchasing any additional interest in the same 
enterprise until the substituted combined voting level decreases below 
20 percent.
    (ii) 25 percent maximum on foundation holdings. If, or as soon as, 
the disqualified person voting level exceeds 2 percent after the 
expiration of the first phase, the permitted holdings shall not 
thereafter exceed 25 percent of the voting stock or 25 percent of the 
value of all outstanding shares of all classes of stock, even though the 
holdings of the foundation and all disqualified persons combined do not 
exceed the substituted level. Solely for purposes of determining whether 
the 25 percent limitation of this subdivision (ii) applies, the 
disqualified person voting level shall not be treated as exceeding 2 
percent solely as a result of the holdings of a private foundation which 
are treated as held by a disqualified person by reason of section 
4943(c) (5) or (6). For example, where under the constructive ownership 
rules for trusts in Sec. 53.4943-8(b), a private foundation is deemed 
to own more than 2 percent of the voting stock of a business enterprise 
but such stock is treated as held by a disqualified person under section 
4943(c)(5), the determination of the substituted percentage for 
permitted holdings in the second phase will be as if the foundation 
owned the stock held by the trust. Similarly, where a private foundation 
is the only remainder beneficiary of a trust that is a disqualified 
person under section 4946(a)(1)(H), the disqualified person voting level 
shall not be treated as exceeding 2 percent solely as a result of the 
holdings of such a trust.
    (6) Permitted holdings--Third phase. For purposes of section 4943 
and this section, the term ``third phase'' means the entire period 
following the second phase. During the third phase the manner of 
determining the permitted holdings of a private foundation to which 
section 4943(c)(4) applies shall be the same as applicable to the second 
phase under paragraph (d)(5) of this section (including the carryover of 
levels from the earlier phase). However, if the 25 percent limit of 
paragraph (d)(5)(ii) of this section never applied during the second 
phase, the substituted combined voting level and the substituted 
combined value level each shall not exceed 35 percent during the third 
phase.
    (7) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. F, a private foundation, owns on May 26, 1969, 30 shares 
of voting stock in corporation Z representing 30 percent of the voting 
power in Z and 15 percent of the value of all outstanding shares of all 
classes of stock in Z, and owns, on such date, 10 shares of nonvoting 
stock in Z representing 10 percent of the value of all outstanding 
shares of

[[Page 124]]

all classes of stock in Z. E and G, the only disqualified persons with 
respect to F, own, on such date, 5 shares each of nonvoting stock in Z. 
The 10 shares of nonvoting stock in Z owned by E and G together 
represent 10 percent of the value of all outstanding shares of all 
classes of stock in Z. Assume further that F cannot meet the 
requirements for the 35 percent test of section 4943(c)(2)(B). For 
purposes of applying section 4943(c)(4)(B) and this paragraph, F has 
excess business holdings in Z (determined without regard to section 
4943(c)(4)), because under section 4943(c)(2)(A) F's permitted holdings 
are 20 percent (20%-0%) of the voting stock since disqualified persons 
have no holdings of voting stock. Therefore, section 4943(c)(4)(B) and 
this paragraph apply, and a disqualified person is treated as holding 
F's shares of both voting and nonvoting stock in Z for the 10-year 
period through May 25, 1979. Thus, since all holdings by F in Z are 
treated as held by a disqualified person during the first phase, F 
cannot be subject to tax under section 4943(a) on its May 26, 1969, 
holdings prior to the termination of the first phase, regardless of 
whether or not disqualified persons purchase additional shares of Z 
during the first phase.
    Example 2. Assume the same facts as in Example (1), and further 
assume that there were no transactions in the stock of Z during the 
first phase (May 26, 1969 through May 25, 1979). During the first phase 
the permitted holdings by F in Z for both the voting stock and the value 
is zero. The disqualified person voting level and the substituted 
combined voting level are each 30 percent, and the disqualified person 
value level and the substituted combined value level are each 35 percent 
(15%+10%+10%). The substituted levels are carried over into the second 
phase. The disqualified person voting level on May 26, 1979, the 
beginning of the second phase, is zero, because the voting shares held 
by F are no longer treated as held by a disqualified person. Therefore, 
F's permitted holdings on such date are 30 percent of the voting stock, 
because such percentage is equal to the excess of the substituted 
combined voting level (30%) over the disqualified person voting level 
(0%). The disqualified person value level on May 26, 1979, is 10 
percent, because the voting and nonvoting shares held by F are no longer 
treated as held by a disqualified person. Therefore, F's permitted 
holdings on such date are 25 percent of the value of Z stock, because 
such percentage is equal to the excess of the substituted combined value 
level (35%) over the disqualified person value level (10%) as of such 
date.
    Example 3. Assume the facts as stated in Example (2), except that E 
and G acquire, on February 1, 1970, 10 shares of Z voting stock 
representing 10 percent of the voting power in Z and 5 percent of the 
value of all outstanding shares of all classes of stock in Z. During the 
first phase such permitted holdings remain zero, and prior to May 25, 
1979, the substituted combined voting level and substituted combined 
value level remain 30 and 35 percent, respectively, because such levels 
may not be increased by acquisitions by disqualified persons. However, 
the disqualified person voting level and the disqualified person value 
level are each increased to 40 percent (30%+10%) and 40 percent (35%+5%) 
respectively. During the first phase the excess of the disqualified 
person voting level over the substituted combined voting level (40%-30%) 
and the excess of the disqualified person value level over the 
substituted combined value level (40%-35%) indicate how much stock F 
must dispose of during the first phase to avoid the initial tax when it 
expires. On May 25, 1979, the last day of the first phase, F disposes of 
12 shares of Z voting stock, representing 12 percent of the voting power 
in Z and 6 percent of the value of all such outstanding shares. The 
disposition by F reduces the interest F owns to 18 percent (30%-12%) of 
the voting power, and 19 percent (25%-6%) of the value of all 
outstanding shares of all classes of stock, in Z. Since the disqualified 
person voting level decreases to 28 percent (40%-12%), the substituted 
combined voting level as of May 25, 1979, accordingly is decreased to 28 
percent under the downward ratchet rule. Similarly, the substituted 
combined value level is decreased to 34 percent, as the disqualified 
person value level as of such date is 34 percent (40%-6%). On May 26, 
1979, the disqualified person voting level is 10 percent (28%-18%), and 
the disqualified person value level is 15 percent (34%-19%), since the 
shares owned by F are no longer treated as held by a disqualified person 
as of such date. Accordingly, on May 26, 1979, the permitted holdings by 
F and Z are 18 percent of the voting power in Z, because such percentage 
is equal to the excess of the substituted combined voting level (28%) 
over the disqualified person voting level (10%) as of such date. 
Similarly, the permitted holdings of F in Z by value are 19 percent 
(34%-15%). If F had not disposed of the 12 shares, then on May 26, 1979, 
F's permitted holdings in voting power and value would be 20 percent 
(30%-10%) and 20 percent (35%-15%), respectively.
    Example 4. F, a private foundation, owns on May 26, 1969, 35 shares 
of voting stock in corporation Y representing 35 percent of the voting 
stock in Y and 17.5 percent of the value of all classes of stock in Y, 
and owns on such date 45 shares of nonvoting stock representing 22.5 
percent of the value of all outstanding shares of all classes of stock 
in Y. No disqualified person with respect to F owns, on such date, any 
stock in Y. Assume further that Y cannot meet the requirements of the 35 
percent test of section 4943(c)(2)(B). For purposes of applying section 
4943(c)(4)(B) and this paragraph, F has excess business

[[Page 125]]

holdings in Y (determined without regard to section 4943(c)(4)), because 
under section 4943(c)(2)(A) F's permitted holdings are 20 percent (20%-
0%) of the voting stock since disqualified persons have no holdings of 
voting stock. Therefore, section 4943(c)(4)(B) and this paragraph apply, 
and a disqualified person is treated as holding F's shares of both 
voting and nonvoting stock in Y for the 10-year period through May 25, 
1979. During the first phase the permitted holdings by F in Y of both 
the voting stock and of value are zero. The disqualified person voting 
level and the substituted combined voting level are each 35 percent, and 
the disqualified person value level and the substituted combined value 
level are each 40 percent (17.5%+22.5%). The substituted levels are 
carried over into the second phase. The disqualified person voting level 
and value level on May 26, 1979, are both zero, because the shares held 
by F are no longer treated as held by a disqualified person. Therefore, 
F's permitted holdings on such date are 35 percent of the voting power 
(35%-0%) and 40 percent of the value (40%-0%). Assume that on February 
1, 1981, A, a disqualified person, acquires 6 percent of the voting 
stock in Y representing 3 percent of the value of all outstanding shares 
of all classes of stock in Y. The permitted holdings by F in Z on 
February 1, 1981, are thus reduced to 25 percent of the voting stock 
(the lesser of the separate 25% second phase limitation or 29% (35% 
substituted combined voting level minus 6% disqualified person voting 
level)) and 25 percent of the value (the lesser of the separate 25% 
second phase limitation or 37% (40% substituted combined value level 
minus 3% disqualified person value level)). But see paragraph (d)(8) of 
this section for limitations on restrictions with respect to nonvoting 
stock.
    Example 5. Assume the same facts as in Example (4) except that A 
does not acquire the 6 shares of voting stock until February 1, 1996 (in 
the third phase), rather than on February 1, 1981. Thus, F's permitted 
holdings in Y would remain at 35 percent of the voting stock and 40 
percent of the value during the second phase, which expired on May 25, 
1994. Assume that on May 25, 1994, the last day of the second phase, F 
disposes of 10 shares of nonvoting stock representing 5 percent of the 
value of all outstanding shares in Y to meet the 35 percent third phase 
limit. In accordance with the downward ratchet rule, the substituted 
combined value level and F's permitted holdings in Y would be reduced to 
35 percent of value. On February 1, 1996, F's permitted holdings in Y 
would be reduced to 25 percent of the voting stock (the lesser of the 
separate 25% third phase limitation or 29% (35% substituted combined 
voting level minus 6% disqualified person level)) and 25 percent of the 
value (the lesser of the separate 25% third phase limitation or 32% (35% 
substituted combined value level minus 3% disqualified person value 
level)). But see paragraph (d)(8) of this section for limitations on 
restrictions with respect to nonvoting stock.

    (8) Special rule where all holdings are permitted under section 
4943(c)(2). (i) Since section 4943(c)(4) and this paragraph provide 
transitional rules for foundations which would otherwise have had excess 
business holdings on May 26, 1969, no holdings shall cease to be 
permitted holdings under this paragraph where such holdings would be 
permitted holdings under section 4943(c)(2) and Sec. 53.4943-3. Thus, 
for example, where the substituted combined voting level had been 
reduced to 20 percent, the provisions of Sec. 53.4943-3(b)(2) 
concerning nonvoting stock as permitted holdings generally apply.
    (ii) The provisions of this paragraph (d)(8) may be illustrated by 
the following example:

    Example. (A) F, a private foundation, owns, on May 26, 1969, 40 
shares of voting stock in corporation X representing 40 percent of the 
voting stock in X and 20 percent of the value of all outstanding shares 
of all classes of stock in X, and owns, on such date, 60 shares of 
nonvoting stock in X, representing 30 percent of the value of all 
outstanding shares of all classes of stock in X. A, the only 
disqualified person with respect to F, owns, on such date, 10 shares of 
voting stock in X, representing 10 percent of the voting stock in X and 
5 percent of the value of all outstanding shares of all classes of stock 
in X. Under section 4943(c)(4)(B)(iii), a disqualified person is deemed 
the owner of all holdings by F in X for the 10-year period beginning on 
May 26, 1969.
    (B) Assume that the only transaction in X stock during the first 
phase is the disposition of 30 shares of voting stock by F on May 1, 
1975. The voting stock held by F is permitted holdings under Sec. 
53.4943-3 and under such section since all disqualified persons together 
do not own more than 20 percent of the voting stock in X, all nonvoting 
stock held by F shall also be treated as permitted holdings. Therefore, 
all the stock held by F is permitted holdings.
    (C) Assume that on May 1, 1975, F had disposed of only 15 shares of 
voting stock and also had disposed of 35 shares of nonvoting stock. On 
May 26, 1979, at the beginning of the second phase, this paragraph 
(d)(8) would not apply since F would have excess business holdings under 
Sec. 53.4943-3. Under the provisions of this section, the permitted 
holdings by F in X on such date are 25 percent of the

[[Page 126]]

voting stock (35% substituted combined voting level minus 10% 
disqualified person voting level) and 25 percent of the value (30% 
substituted combined value level minus 5% disqualified person value 
level).

    (9) Special rule for certain private foundations. In the case of a 
private foundation:
    (i) Which was incorporated before January 1, 1951.
    (ii) Substantially all of the assets of which on May 26, 1969, 
consisted of more than 90 percent of the stock of an incorporated 
business enterprise which is licensed and regulated, the sales or 
contracts of which are regulated, and the professional representatives 
of which are licensed, by State regulatory agencies in at least 10 
States;
    (iii) Which acquired such stock solely by gift, devise, or bequest;
    (iv) Which does not purchase any stock or other interest in such 
enterprise after May 26, 1969, and does not acquire any stock or other 
interest in any other business enterprise which constitutes excess 
business holdings under Sec. 53.4943-3; and
    (v) Which, in the last 5 taxable years ending on or before December 
31, 1970, expended substantially all of its adjusted net income (as 
defined in section 4942(f)) for the purpose or function for which it is 
organized and operated;

paragraph (d) (1) through (5) of this section (permitted holdings during 
the first and second phase) shall be applied with respect to the 
holdings of such foundation in such incorporated business enterprise by 
substituting ``51 percent'' for ``50 percent,'' and section 
4943(c)(4)(D) (third phase) shall not apply with respect to such 
holdings. For purposes of the preceding sentence, stock of such 
enterprise in a trust created before May 27, 1969, of which the 
foundation is the remainder beneficiary shall be deemed to be held by 
such foundation on May 26, 1969, if such foundation held (without regard 
to such trust) more than 20 percent of the stock of such enterprise on 
May 26, 1969.
    (10) Special rule for changes in the relative values of stock of 
different classes. (i) In the case of a corporation that has more than 
one class of stock outstanding, if the percentage of value held by the 
private foundation, its disqualified persons, or both, increases over a 
period of time solely as a result of changes in the relative values of 
the stock of different classes, then the foundation value level, the 
disqualified person value level, and the substituted combined value 
level, as defined in paragraph (d)(2) of this section, shall be adjusted 
to reflect such increase. An increase in the percentage of value held 
shall not be considered to have occurred solely as a result of changes 
in the relative values of the stock of different classes if:
    (A) There has been any increase during the period in the percentage 
of any class of stock held by the private foundation, its disqualified 
persons, or both, or
    (B) There has been any issuance, redemption, or purchase by the 
issuing corporation of any stock during the period.

See Sec. 53.4943-6(d) for rules relating to increases caused by 
readjustments.
    (ii) Example. The provisions of this paragraph (b)(10) may be 
illustrated by the following example:

    Example. (i) At all times since May 26, 1969, F, a private 
foundation, has held 25% (500,000 shares) of the outstanding class of 
voting stock of X corporation. No disqualified person with respect to F 
holds any voting stock of X. In addition X has had outstanding since May 
26, 1969, a class of non-voting preferred stock, none of which is held 
by F or a disqualified person. X is an active business corporation and 
third parties do not have effective control of X. On May 26, 1969, the 
voting stock (2 million shares outstanding) was trading for $5 a share 
on the New York Stock Exchange. The non-voting preferred stock, not 
publicly traded, was valued at $1 million. The total value of all 
outstanding stock was $11 million ($10 million voting stock plus $1 
million non-voting preferred). On May 26, 1969, F held 22.73% of the 
value of X's outstanding stock ($2.5 million/$11 million).
    (ii) On October 31, 1982, X's voting stock is trading for $20 a 
share and the nonvoting stock is valued at $3 million. At all times 
during the period May 26, 1969, through October 31, 1982, F has held 25 
percent of the voting stock and none of the nonvoting stock of X. No 
stock of X is owned by disqualified persons. No stock of X has been 
issued, redeemed or purchased by X during this period. On October 13, 
1982, the total value of X's outstanding stock (is $43 million ($40 
million voting stock and $3 million nonvoting stock) and F holds 23.26 
percent of the value of X's outstanding stock ($10 million/$43 million).

[[Page 127]]

F's foundation value level and the substituted combined value level are 
increased from 22.73 percent to 23.26 percent to reflect this change.
    (iii) On November 1, 1982, X corporation distributes the stock of Y 
corporation, a wholly-owned subsidiary, to X's shareholders. Y is a 
business enterprise. Under this paragraph (d)(10), all of F's stock in X 
is permitted holdings under section 4943 (c)(4) even though the 
percentage of value held by F has increased from 22.73 percent on May 
26, 1969, to 23.26 percent on November 1, 1982. F's permitted holdings 
in Y will be determined by reference to F's permitted holdings in X 
under Sec. 53.4943-7. Therefore, assuming no prohibited transaction 
occurs, F's permitted holdings in Y stock equal 25 percent of Y's voting 
stock and, separately, 23.26 percent of the value of all of Y's 
outstanding stock.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6478, Feb. 22, 1984]



Sec. 53.4943-5  Present holdings acquired by trust or a will.

    (a) Interests to which section 4943(c)(5) applies--(1) In general. 
Section 4943(c)(5) provides that section 4943(c)(4) (other than the 20-
year first phase holding period) applies to an interest in a business 
enterprise acquired after May 26, 1969 by a private foundation under the 
terms of a trust which was irrevocable on May 26, 1969, or under the 
terms of a will executed on or before May 26, 1969, which were in effect 
on May 26, 1969, and at all times thereafter, as if such interest were 
held on May 26, 1969. However the first phase holding period prescribed 
by Sec. 53.4943-4(c)(1) (ii) or (iii) shall commence for such an 
interest on the date of distribution to the foundation. Unlike section 
4943(c)(4) and Sec. 53.4943-4, section 4943(c)(5) and this section 
treat only the interest so acquired (and not the entire interest held by 
the foundation in such enterprise on the date of distribution) as held 
by a disqualified person during a first phase holding period. (See, 
however, section 4943(c)(6) and paragraph (b)(2) of Sec. 53.4943-6 for 
the treatment of other holdings of the foundation in the same enterprise 
if an interest to which section 4943(c)(5) applies is acquired from a 
person who was not a disqualified person prior to the acquisition.) In 
addition, section 4943(c)(5) and this section shall not apply if after 
the acquisition of such an interest the foundation would not have excess 
business holdings (determined without regard to section 4943(c) (4), 
(5), or (6)).
    (2) After-acquired interests. Section 4943(c)(5) and this section 
shall not apply to any interest acquired after May 26, 1969, by an 
estate or trust, other than by reason of the death of the decedent. For 
example, where a foundation is a residuary beneficiary under the terms 
of a will executed before May 26, 1969, and the residue of the estate 
consists of cash, then stock subsequently purchased with cash for 
distribution to the foundation will not be treated as an interest 
acquired under the terms of a will executed on or before May 26, 1969.
    (3) Certain revocable trusts. If an interest in a business 
enterprise actually passes to a private foundation under a trust which 
would have met the tests referred to in paragraph (a)(1) of this section 
but for the fact that the trust was revocable (even though it was not in 
fact revoked) and such interest would have passed to such foundation 
under a will that meets those tests but for the fact that the grantor 
died without having revoked the trust, then for purposes of section 
4943(c)(5) and this section, such an interest shall be treated as having 
been acquired by the foundation under the will.
    (4) Modification of will--(i) In general. For purposes of section 
4943(c)(5) and this section, an amendment or republication of a will 
which was executed on or before May 26, 1969, does not prevent any 
interest in a business enterprise which was to pass under the terms 
(which were in effect on May 26, 1969, and at all times there- after) of 
such will from being treated as a present holding under section 4943(c) 
(4) or (5):
    (A) Solely because there is a reduction in the interest in the 
business enterprise which the foundation was to receive under the terms 
of the will (for example, if the foundation is to receive the residuary 
estate, and if one class of stock is disposed of by the decedent during 
his lifetime or by a subsequent codicil);
    (B) Solely because such amendment or republication is necessary in 
order to comply with section 508(e) and the regulations thereunder;

[[Page 128]]

    (C) Solely because there is a change in the executor of the will; or
    (D) Solely because of any other change which does not otherwise 
change the rights of the foundation with respect to such interest in the 
business enterprise.

However, if under such amendment or republication there is an increase 
in the interest in the business enterprise which the foundation was to 
receive under the terms of the will in effect on May 26, 1969, such 
increase shall not be treated as present holdings under section 4943(c) 
(4) or (5). Under such circumstances the interest which would have been 
acquired before such increase shall remain present holdings. See section 
4943(c)(6) and Sec. 53.4943-6 with respect to the treatment of such 
increase in holdings of a private foundation.
    (ii) Examples. The provisions of this paragraph (a)(4) may be 
illustrated by the following examples:

    Example 1. On May 9, 1985, A modifies by codicil his will which was 
in effect on May 26, 1969, and was unchanged until such modification. 
The purpose of the codicil was, in the event of A's death, to increase 
the number of shares in X Corporation that would pass to the W 
foundation from 70 percent of all the voting power and value to 80 
percent. Under these facts, if A dies without further modifying the 
terms of the will which apply to W's interest in X, section 4943(c)(5) 
will apply to 70 percent of the X voting power and value and section 
4943(c)(6) will apply to 10 percent of the X voting power and value, 
since 10 percent of the X voting power and value would not pass under a 
provision of the will which was in effect on May 26, 1969, and at all 
times thereafter. Accordingly, if the stock is distributed to W on July 
6, 1988, then, assuming that on May 26, 1969, W and all disqualified 
persons owned less than 75% of the voting stock in X, an amount of such 
stock representing 70 percent of X voting power and value shall be 
treated as held by a disqualified person through July 5, 1998, and an 
amount of such stock representing 10 percent of X voting power and value 
shall be treated as held by a disqualified person through July 5, 1993.
    Example 2. Assume the facts as stated in Example (1), except that 
the sole purpose of the codicil was to change the executor of the will. 
Under paragraph (a)(4)(i) of this section, such codicil will not prevent 
the X voting stock which was bequeathed to W from being treated as held 
by a disqualified person through July 5, 1998.

    (b) Holding periods--(1) In general. An interest to which section 
4943(c)(5) applies shall be entitled to a 15-year holding period 
starting on the date of distribution only if the interests actually or 
constructively owned by a private foundation and all disqualified 
persons on May 26, 1969, in a business enterprise exceed 75 percent of 
the voting stock (or of the profits or beneficial interest) or 75 
percent of the value of all outstanding shares of all classes of stock 
(or of the profits and capital interest) in such enterprise. For 
purposes of the preceding sentence, interests held by the foundation on 
May 26, 1969, shall be deemed to include an interest to which section 
4943(c)(5) applies and which has been acquired (on or before the date of 
distribution for the interest in question) from a person who was not a 
disqualified person on May 26, 1969. Therefore, if under the terms of a 
will in effect on May 26, 1969, and at all times thereafter, a private 
foundation is created on July 1, 1975, and receives 76 percent of the 
voting stock of a business enterprise on that date, such stock shall be 
treated as held by a disqualified person until June 30, 1990. Any 
interest to which section 4943(c)(5) applies but which is not entitled 
to a 15-year holding period shall be entitled to a 10-year holding 
period starting on the date of distribution. For purposes of this 
paragraph the date of distribution shall be deemed to occur no later 
than the date on which the trust or estate is considered to be 
terminated under Sec. 1.641(b)-(3) of this chapter (Income Tax 
Regulations).
    (2) Constructive ownership prior to date of distribution. To the 
extent that an interest to which section 4943(c)(5) applies is 
constructively held by a private foundation under section 4943(d)(1) and 
Sec. 53.4943-8 prior to the date of distribution, it shall be treated 
as held by a disqualified person prior to such date by reason of section 
4943(c)(5). In addition, in the case of a foundation's interest in a 
trust which was irrevocable on May 26, 1969, and to which both sections 
4943 (c)(4) and (c)(5) apply, the first phase holding period for such 
interest shall end with whichever such period under section 4943(c) (4) 
or (5) ends later. For example, if under the terms of such a trust, 96 
percent of the

[[Page 129]]

voting stock in a business enterprise was constructively held by a 
private foundation on May 26, 1969, and was distributed to such 
foundation on June 30, 1970, such interest is entitled to a 20-year 
holding period beginning on May 26, 1969.
    (c) Permitted holdings--(1) In general. The permitted holdings of a 
private foundation which has an interest in a business enterprise to 
which section 4943(c)(5) applies shall be determined in accordance with 
the rules of paragraph (d) of Sec. 53.4943-4. The levels referred to in 
such paragraph shall be adjusted to take into account the acquisition of 
such an interest as if it were treated as held by a disqualified person 
from May 26, 1969, until the date of acquisition. See also Sec. 
53.4943-6(b)(2) for the special rule for interests held by a private 
foundation at the time it acquires a section 4943(c)(5) interest from a 
nondisqualified person. Thus, for example, if on June 30, 1975, the 
disqualified person voting level and the substituted combined voting 
level in corporation X with respect to foundation F are 45 percent, and 
a nondisqualified person's 10 percent voting interest in X is acquired 
by F on July 1, 1975, in a transaction to which section 4943(c)(5) 
applies, the above-mentioned levels shall be increased to 55 and 50 
percent respectively, on July 1, 1975. However, if such interest had 
been acquired from a person who was a disqualified person on May 26, 
1969, rather than from a nondisqualified person, no adjustments in such 
levels would have taken place on July 1, 1975. In such a case, though, 
at the beginning of the second phase on July 1, 1985, the foundation 
voting level would be increased by 10 percent, and the disqualified 
person voting level decreased by 10 percent (assuming that none of the 
acquired stock had been disposed of prior to such date).
    (2) Separate phases. The phases for each interest to which section 
4943(c)(5) applies start independently from those for any other interest 
of the foundation in the same enterprise to which section 4943(c) (4) or 
(5) applies. Therefore, until an interest enters its own second phase, 
the 25 percent limit described in paragraph (d)(5) of Sec. 53.4943-4 
shall not apply to such interest since such interest (and any 
subsequently acquired section 4943(c)(5) interest in the first phase) is 
still treated as held by a disqualified person for purposes of that 25 
percent limit. In addition, if such an interest enters its second phase 
and at such time all disqualified persons together do not have holdings 
in excess of 2 percent of the voting stock in the same business 
enterprise, then the 25 percent limit of section 4943(c)(4)(D)(i) shall 
not then apply to such interest, even though such limit may have been 
applicable to an interest with an earlier second phase. Moreover, the 35 
percent limit of section 4943(c)(4)(D)(ii) shall cause only interests 
which have entered the third phase to become excess business holdings, 
taking into account, however, interests in prior phases in determining 
the holdings subject to such limit.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples: (After each example is a chart setting forth the 
chronological changes in the various levels referred to in paragraph (d) 
of Sec. 53.4943-4.)

    Example 1. On May 26, 1969, F, a private foundation, owns no stock 
in M Corporation, and A, a disqualified person owns 40 percent of the 
voting stock (voting power and value) in M. A dies on May 1, 1971, 
leaving 30 percent of the voting stock in M to F and leaving the other 
10 percent to a disqualified person. Distribution is made on June 1, 
1972, and assume that section 4943(c)(5) applies. No transactions in the 
stock of M, other than those described in this example, occur. On May 
26, 1969, the substituted combined voting level is 40 percent, the 
disqualified person voting level is deemed to be 40 percent, and the 
permitted holdings by F in M is deemed to be 0 percent (40%-40%). On May 
1, 1971 (the date that F acquired the M stock by reason of its 
constructive ownership of A's estate), the various levels remain 
unchanged. On May 1, 1971, the 30 percent interest is treated as held by 
a disqualified person for a period extending through May 31, 1982. On 
June 1, 1981, F disposes of 6 percent of the voting stock to a 
nondisqualified person. The substituted combined voting level and the 
disqualified person voting level thereby are reduced to 34 percent (40%-
6%) each. On June 1, 1982, at the beginning of the second phase, the 
foundation voting level increases to 24 percent (30%-6%) and the 
disqualified person voting level is reduced to 10 percent (34%-10%). The 
substituted combined voting level as of June 1, 1982, remains at 34 
percent. The permitted holdings as of such date are 24 percent (34%-
10%). If F had not disposed of any holdings prior to June 1, 1982,

[[Page 130]]

F's permitted holdings would have been 25 percent, the lesser of 25 
percent (the limitation of section 4943(c)(4)(D)(i)), or 30 percent 
(40%-10%). Since on such date the 30 percent interest would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 5 percent (30%-25%).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    Interest
                                                   treated as                 Foundation  Substituted  Disqualified
                                         F owns      held by    Disqualified    voting      combined      person     Permitted
                 Date                  (percent)  disqualified   persons own     level       voting    voting level   holdings          Comments
                                                     person       (percent)    (percent)     level       (percent)   (percent)
                                                    (percent)                              (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969.........................          0            0            40            0          40            40           0
May 1, 1971..........................        +30          +30           -30   ..........  ...........  ............  .........  A dies.
 Do..................................         30           30            10            0          40            40           0
June 1, 1972.........................         30           30            10            0          40            40           0  Distribution.
June 1, 1981.........................         -6           -6   ............  ..........          -6            -6   .........  F sells 6 pct.
 Do..................................         24           24            10            0          34            34           0
June 1, 1982.........................  .........          -24   ............         +24  ...........          -24         +24  2d phase begins.
 Do..................................         24            0            10           24          34            10          24
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 2. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock of N Corporation (voting power and value) 
and disqualified persons own 20 percent of the voting stock of N 
Corporation. On May 1, 1971, B, a disqualified person, dies leaving 15 
percent of the voting stock to F. Assume the distribution was made on 
June 1, 1972, and that section 4943(c)(5) applies. On May 26, 1969, the 
substituted combined voting level and the disqualified person voting 
levels are each 50 percent and the permitted holdings are 0 percent 
(50%-50%). On May 1, 1971, and June 1, 1972, these levels remain 
unchanged. On May 1, 1971, the 15 percent interest is treated as held by 
a disqualified person for a period extending through May 31, 1982.
    (ii) On July 1, 1978, F sells 6 percent of the F stock to a 
nondisqualified person, thereby reducing the disqualified person voting 
level and the substituted combined voting level to 44 percent (50%-6%). 
On May 26, 1979, at the beginning of the second phase for F's 1969 
holdings, the foundation voting level is 24 percent (30%-6%), the 
substituted combined voting level is still 44 percent, and the 
disqualified person voting level is 20 percent (44%-24%). The permitted 
holdings are 24 percent (44%-20%). In addition F's 24 percent holdings 
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i) and 
paragraph (d)(5)(ii) of Sec. 53.4943-4.
    (iii) On August 1, 1981, F sells 16 percent of the N stock to a 
nondisqualified person, thereby reducing the foundation voting level to 
8 percent (24%-16%), and reducing the substituted combined voting level 
to 28 percent (44%-16%). The disqualified person voting level remains at 
20 percent. On June 1, 1982, at the beginning of the second phase for 
F's holdings acquired by will, the substituted combined voting level is 
still 28 percent, the foundation voting level is 23 percent (8%+15%), 
the disqualified person voting level is 5 percent (20%-15%), and the 
permitted holdings are 23 percent (28%-5%).
    (iv) If F had not disposed of the 6 percent on July 1, 1978, then on 
May 26, 1979, at the beginning of the second phase for F's 1969 
holdings, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (the limitation of section 4943(c)(4)(D)(i), or 30 percent 
(50%-20%). Since F's 30 percent interest would no longer have been 
treated as held by a disqualified person on May 26, 1979, F would have 
had excess business holdings of 5 percent (30%-25%). Similarly, if F had 
not disposed of the 16 percent interest on August 1, 1981 (but had 
disposed of the 6 percent interest), on July 1, 1982, at the beginning 
of the second phase for F's holdings acquired by will, F's permitted 
holdings would have been 25 percent, the lesser of 25 percent (under 
section 4943(c)(4)(D)(i)), or 39 percent (44%-5%). Since as of such date 
F's entire holdings of 39 percent would no longer have been treated as 
held by a disqualified person, F would have had excess business holdings 
of 14 percent (39%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0

[[Page 131]]

 
May 1, 1971...................................       +15   .........       +15          +15           -15    ..........  ...........  ............  .........  B dies.
 Do...........................................        45         30         15           45             5            0          50            50           0
June 1, 1972..................................        45         30         15           45             5            0          50            50           0   Distribution.
July 1, 1978..................................        -6         -6   .........          -6    ............  ..........         -6            -6    .........  F sells 6 pct.
 Do...........................................        39         24         15           39             5            0          44            44           0
May 16, 1979..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        39         24         15           15             5           24          44            20          24
Aug. 1, 1981..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F sells 16 pct.
 D0...........................................        23          8         15           15             5            8          28            20           8
July 1, 1982..................................  .........  .........  .........         -15    ............        +15   ...........         -15         +15   All in 2d phase.
 Do...........................................        23          8         15            0             5           23          28             5          23
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example. (3). (i) On May 26, 1969, F, a private foundation owns 5 
percent of the voting stock of O Corporation (voting power and value), 
and disqualified persons own 45 percent of the voting stock. C, a 
disqualified person, dies on May 1, 1971, and leaves 41 percent of the 
voting stock of O to F. Assume that distribution is made on June 1, 
1972, and that section 4943(c)(5) applies. On May 26, 1969, the 
substituted combined voting level and the disqualified person voting 
level are 50 percent and the permitted holdings are 0 percent (50%-50%). 
On May 1, 1971, and June 1, 1972, the various levels remain unchanged. 
On May 1, 1971, the 41 percent interest is treated as held by a 
disqualified person for a period extending through May 31, 1982. On May 
26, 1979, at the beginning of the second phase for F's 1969 holdings of 
5 percent, the 5 percent is no longer treated as held by a disqualified 
person, the foundation voting level is 5 percent, the disqualified 
person voting level is reduced to 45 percent (50%-5%), and the 
substituted combined voting level remains at 50 percent. On such date 
F's permitted holdings are 5 percent (50%-45%). Since the 41 percent 
interest is treated as held by a disqualified person, the interest 
treated as held by F (5%) does not exceed the 25 percent limitation of 
section 4943(c)(4)(D)(i).
    (ii) On August 1, 1981, F sells 22 percent of the O stock to a 
nondisqualified person, thereby reducing the foundation voting level to 
0 percent. Since the reductions are first applied to the 1969 holdings 
of 5 percent, 17 percent (22%-5%) applies to the 41 percent interest, 
reducing such interest to 24 percent (41%-17%), and reducing the 
disqualified person voting level to 28 percent (45%-17%). The 
substituted combined voting level is reduced to 28 percent (0%+28%). On 
June 1, 1982, at the beginning of the second phase for F's holdings 
acquired by will, the substituted combined voting level remains at 28 
percent, the foundation voting level is 24 percent, the disqualified 
person voting level is reduced to 4 percent (28%-4%).
    (iii) If F had not disposed of the 22 percent interest prior to June 
1, 1982, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent, (under section 4943(c)(4)(D)(i)), or 46 percent (50%-4%). 
Since as of such date, F's entire holdings of 46 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 21 percent (46%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0   .................................
May 1, 1971...................................       +41   .........       +41          +41           -41    ..........  ...........  ............  .........  C dies.
 Do...........................................        46          5         41           46             4            0          50            50           0
June 1, 1972..................................        46          5         41           46             4            0          50            50           0   Distribution.

[[Page 132]]

 
May 26, 1979..................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct.
 Do...........................................        46          5         41           41             4            5          50            45           5
Aug. 1, 1981..................................       -22         -5        -17          -17    ............         -5         -22           -17          -5   F sells 22 pct.
 Do...........................................        24          0         24           24             4            0          28            28           0
June 1, 1982..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24          0         24            0             4           24          28             4          24
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 4. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock in P Corporation (voting power and value), 
and disqualified persons own 20 percent. On May 1, 1971, D, a 
disqualified person, dies leaving 18 percent of the voting stock to F. 
Assume that distribution was made on June 1, 1972, and that section 4943 
(c)(5) applies. On May 26, 1969, the substituted combined voting level 
and the disqualified person voting level are each 50 percent and the 
permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June 1, 
1972, these levels remain unchanged. On May 1, 1971, the 18 percent 
interest is treated as held by a disqualified person for a period 
extending through May 31, 1982. On May 26, 1979, the foundation voting 
level increases to 30 percent, the disqualified person voting level 
decreases to 20 percent (50%-30%), and the permitted holdings are 30 
percent (50%-20%). On June 1, 1982, the foundation voting level 
increases to 48 percent, the disqualified person voting level decreases 
to 2 percent and the permitted holdings are 48 percent (50%-2%). Since 
at no time during the second phase for F's 1969 holdings did all 
disqualified persons together have holdings in excess of 2 percent of 
the voting stock of P, the 25 percent limitation of section 
4943(c)(4)(D)(i) did not apply to F's 1969 holdings.
    (ii) On July 1, 1993, F disposes of 16 percent of the stock in P, 
thereby reducing the substituted combined voting level to 34 percent 
(50%-16%), and reducing the permitted holdings to 32 percent (34%-2%). 
If F had not disposed of the 16 percent of the stock of P prior to May 
26, 1994, on such date, under section 4943(c)(4)(D)(ii), F's substituted 
combined voting level for its 1969 holdings would have been 35 percent, 
and the permitted holdings would have been 33 percent (35%-2%). Since 
none of F's holdings of 48 percent would have been treated as held by a 
disqualified person on such date (the beginning of the third phase for 
F's 1969 holdings), F would have had excess business holdings of 15 
percent, the lesser of 30 percent (F's 1969 holdings in the third 
phase), of 15 percent (the excess of F's 48 percent holdings over the 
permitted holdings of 33 percent).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0
May 1, 1971...................................       +18   .........       +18          +18           -18    ..........  ...........  ............  .........  D dies.
 Do...........................................        48         30         18           48             2            0          50            50           0
June 1, 1972..................................        48         30         18           48             2            0          50            50           0   Distribution.
May 26, 1979..................................  .........  .........  .........         -30    ............        +30   ...........         -30         +30   2d phase for 30 pct.
 Do...........................................        48         30         18           18             2           30          50            20          30
June 1, 1982..................................  .........  .........  .........         -18    ............        +18   ...........         -18         +18   2d phase for 18 pct.
 Do...........................................        48         30         18            0             2           48          50             2          48
July 1, 1993..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F disposes of 16 pct.
 Do...........................................        32         14         18            0             2           32          34             2          32

[[Page 133]]

 
May 26, 1994..................................        32         14         18            0             2           32          34             2          32   3d phase for 14 pct.
June 1, 1997..................................        32         14         18            0             2           32          34             2          32   3d phase for 18 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 5. (i) On May 26, 1969, F, a private foundation, owns 5 
percent of the voting stock in Q Corporation (voting power and value), 
and disqualified persons own 45 percent. On May 1, 1971, E, a 
disqualified person, dies leaving 43 percent of the voting stock to F. 
Assume that distribution was made on June 2, 1972, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and the disqualified person voting level are each 50 percent and 
the permitted holdings are 0 percent (50%-50%). On May 1, 1971, and June 
1, 1972, these levels remain unchanged. On May 1, 1971, the 43 percent 
interest is treated as held by a disqualified person for a period 
extending through May 31, 1982. On May 26, 1979, the foundation voting 
level increases to 5 percent, the disqualified person voting level 
decreases to 45 percent, and the permitted holdings are 5 percent (50%-
45%). On June 1, 1982, the foundation voting level increases to 48 
percent, the disqualified person voting level decreases to 2 percent, 
and the permitted holdings are 48 percent (50%-2%). At no time during 
the second phase for F's 1969 holdings did all disqualified persons 
together have holdings in excess of 2 percent of the voting stock of Q. 
Therefore, the 25 percent limitation of section 4943(c)(4)(D)(i) did not 
apply.
    (ii) On July 1, 1993, F sells 6 percent of the stock in Q to a 
nondisqualified person. This reduces the substituted combined voting 
level to 44 percent and reduces the permitted holdings to 42 percent 
(44%-2%). If F had not disposed of the 6 percent of the stock in 1993, 
on May 26, 1994, at the beginning of the third phase for F's 1969 
holdings, F would have had 5 percent excess business holdings. The 
excess business holdings are 5 percent because although the excess 
business holdings computed for the third phase are 15 percent (the 
excess of F's actual holdings (48%) over the permitted holdings of 33 
percent (35%-2%)), only 5 percent of the holdings are in this phase and 
subject to the 35 percent combined holdings limitation.
    (iii) On July 1, 1995, F sells 10 percent of the stock in Q, thereby 
reducing the substituted combined voting level to 34 percent and 
reducing the permitted holdings to 32 percent (34%-2%). If F had not 
disposed of the 10 percent of the stock, on June 1, 1997, at the 
beginning of the third phase for F's acquired holdings, F would have had 
9 percent excess business holdings (the excess of F's total holdings in 
the third phase (42%) over the permitted holdings of 33 percent (35%-
2%)).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                 F's owns   interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1971    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0
May 1, 1971...................................       +43   .........       +43          +43           -43    ..........  ...........  ............  .........  E dies.
 Do...........................................        48          5         43           48             2            0          50            50           0
June 1, 1972..................................        48          5         43           48             2            0          50            50           0   Distribution.
May 26, 1979..................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct
 Do...........................................        48          5         43           43             2            5          50            45           5
June 1, 1982..................................  .........  .........  .........         -43    ............        +43   ...........         -43         +43   2d phase for 43 pct.
 Do...........................................        48          5         43            0             2           48          50             2          43
July 1, 1993..................................        -6         -5         -1   ............  ............         -6          -6    ............        -6   F sells 6 pct.
 Do...........................................        42          0         42            0             2           42          44             2          42
July 1, 1995..................................       -10   .........       -10   ............  ............        -10         -10    ............       -10   F sells 10 pct.

[[Page 134]]

 
 Do...........................................        32          0         32            0             2           32          34             2          32
June 1, 1997..................................        32          0         32            0             2           32          34             2          32   3d phase for 32 pct.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 6. (i) On May 26, 1969, F, a private foundation, owns 30 
percent of the voting stock in R Corporation (voting power and value), 
and disqualified persons own 20 percent. On August 1, 1978, F disposes 
of 6 percent of the stock to a nondisqualified person. On May 1, 1981, 
G, a disqualified person, dies leaving 15 percent of the voting stock to 
F. Assume that distribution was made on June 1, 1982, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and the disqualified person voting level are each 50 percent, and 
the permitted holdings are 0 percent (50%-50%). On August 1, 1978, these 
levels decrease to 44 percent (50%-6%). On May 26, 1979, the foundation 
voting level increases to 24 percent (30%-6%), the disqualified person 
voting level decreases to 20 percent (44%-24%), and the permitted 
holdings are 24 percent (44%-20%). If F had not disposed of the 6 
percent of the stock prior to May 26, 1979, on May 26, 1979, the 
beginning of the second phase for F's 1969 holdings, F's permitted 
holdings would have been 25 percent, the lesser of 25 percent (under 
section 4943(c)(4)(D)(i)) or 30 percent (50%-20%). Since the 30 percent 
interest would no longer have been treated as held by a disqualified 
person on such date, F would have had excess business holdings of 5 
percent (30%-25%).
    (ii) On May 1, 1981, and June 1, 1982 (assuming F had disposed of 
the 6 percent holdings), the foundation voting level, the disqualified 
person voting level, the substituted combined voting level and permitted 
holdings remain respectively 24 percent, 20 percent, 44 percent and 24 
percent. On May 1, 1981, the 15 percent interest is treated as held by a 
disqualified person for a period extending through May 31, 1992. On July 
1, 1991, F sells 16 percent of the voting stock in R to a 
nondisqualified person, thereby reducing the substituted combined voting 
level to 28 percent (44%-16%), and reducing the foundation voting level 
to 8 percent (24%-16%). The disqualified person voting level remains at 
20 percent. On June 1, 1992, at the beginning of the second phase for 
F's holdings acquired by will, the substituted combined voting level 
remains at 28 percent, the foundation voting level increases to 23 
percent (8%+15%) and the disqualified person voting level decreases to 5 
percent (20%-15%). The permitted holdings on such date are 23 percent 
(28%-5%). If F had not disposed of the 16 percent interest prior to June 
1, 1992, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (under section 4943 (c)(4)(D)(i)) or 39 percent (44%-5%). 
Since as of such date, F's entire holdings of 39 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 14 percent (39%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                 F's owns   interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1981    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)   (percent)
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................        30         30   .........          30            20            0          50            50           0
Aug. 1, 1978..................................        -6         -6   .........          -6    ............  ..........         -6            -6    .........  F disposes of 6 pct.
 Do...........................................        24         24   .........          24            20            0          44            44           0
May 26, 1979..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24         24   .........           0            20           24          44            20          24
May 1, 1981...................................       +15   .........       +15          +15           -15    ..........  ...........  ............  .........  G dies.
 Do...........................................        39         24         15           15             5           24          44            20          24
June 1, 1982..................................        39         24         15           15             5           24          44            20          24   Distribution.
July 1, 1991..................................       -16        -16   .........  ............  ............        -16         -16    ............       -16   F disposes of 16 pct.
 Do...........................................        23          8         15           15             5            8          28            20           8

[[Page 135]]

 
June 1, 1992..................................  .........  .........  .........         -15    ............        +15   ...........         -15         +15   2d phase for 15 pct.
 Do...........................................        23          8         15            0             5           23          28             5          23
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 7. (i) On May 26, 1969, F, a private foundation, owns 5 
percent of the voting stock in S Corporation (voting power and value), 
and disqualified persons own 45 percent. On May 1, 1980, H, a 
disqualified person, dies leaving 41 percent of the voting stock to F. 
Assume that distribution is made on June 1, 1981, and that section 
4943(c)(5) applies. On May 26, 1969, the substituted combined voting 
level and disqualified person voting levels are each 50 percent. On May 
26, 1979, the disqualified person voting level decreases to 45 percent, 
the foundation voting level increases to 5 percent, and the permitted 
holdings are 5 percent (50%-45%). On May 1, 1980, and June 1, 1981, the 
levels remain the same. Since the 41 percent holdings are treated as 
held by a disqualified person for the period beginning on May 1, 1980, 
and extending through May 31, 1991, F's remaining holdings of 5 percent 
do not exceed the 25 percent limitation of section 4943(c)(4)(D)(i).
    (ii) On August 1, 1990, F sells 22 percent of the voting stock of S 
to a nondisqualified person, reducing the 5 percent foundation voting 
level to zero, leaving 17 percent (22%-5%) to reduce the disqualified 
person voting level to 28 percent (45%-17%) so that the substituted 
combined voting level equals 28 percent (50%-22%). On June 1, 1991, the 
beginning of the second phase for the remaining 24 percent (41%-17%) of 
F's holdings acquired by will, the foundation voting level increases 
from zero to 24 percent, the disqualified person voting level decreases 
to 4 percent (28%-24%), the substituted combined voting level remains at 
28 percent, and the permitted holdings equal 24 percent (28%-4%).
    (iii) If F had not disposed of the 22 percent holdings prior to June 
1, 1991, F's permitted holdings would have been 25 percent, the lesser 
of 25 percent (under section 4943(c)(4)(D)(i)) or 46 percent (50%-4%). 
Since as of such date, F's entire holdings of 46 percent would no longer 
have been treated as held by a disqualified person, F would have had 
excess business holdings of 21 percent (46%-25%).

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Interest
                                                              F's        F's      treated as                 Foundation  Substituted  Disqualified
                                                  F owns    interest   interest     held by    Disqualified    voting      combined      person     Permitted
                     Date                       (percent)     1969       1980    disqualified   persons own     level       voting    voting level   holdings               Comments
                                                           (percent)  (percent)     person       (percent)    (percent)     level       (percent)    (percent
                                                                                   (percent)                              (percent)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
May 26, 1969..................................         5          5   .........           5            45            0          50            50           0
 Do...........................................  .........  .........  .........          -5    ............         +5   ...........          -5          +5   2d phase for 5 pct.
May 26, 1969..................................         5          5   .........           0            45            5          50            45           5
May 1, 1980...................................       +41   .........       +41          +41           -41    ..........  ...........  ............  .........  H dies.
 Do...........................................        46          5         41           41             4            5          50            45           5
June 1, 1981..................................        46          5         41           41             4            5          50            45           5   Distribution.
Aug. 1, 1990..................................       -22         -5        -17          -17    ............         -5         -22           -17          -5   F disposes of 22 pct.
 Do...........................................        24          0         24           24             4            0          28            28           0
June 1, 1991..................................  .........  .........  .........         -24    ............        +24   ...........         -24         +24   2d phase for 24 pct.
 Do...........................................        24          0         24            0             4           24          28             4          24
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 136]]



Sec. 53.4943-6  Five-year period to dispose of gifts, bequests, etc.

    (a) In general--(1) Application. (i) Paragraph (6) of section 
4943(c) prescribes transition rules for a private foundation, which, but 
for such paragraph, would have excess business holdings as a result of a 
change in the holdings in a business enterprise after May 26, 1969 
(other than by purchase by such private foundation or by a disqualified 
person) to the extent that section 4943(c)(5) (relating to certain 
holdings acquired under a pre-May 27, 1969, will on trust) does not 
apply.
    (ii) Subparagraph (A) of section 4943(c)(6) applies where, 
immediately prior to a change in holdings described in paragraph 
(a)(1)(i) of this section, the foundation has no excess business 
holdings in such enterprise (determined without regard to section 
4943(c) (4), (5), or (6)). In such a case, the entire interest of the 
foundation in such enterprise (immediately after such change) shall 
(while held by the foundation) be treated as held by a disqualified 
person (rather than by the foundation) during the five-year period 
beginning on the date of such change.
    (iii) Subparagraph (B) of section 4943(c)(6) applies where the 
foundation has excess business holdings in such enterprise (determined 
without regard to section 4943(c) (4), (5), or (6)) immediately prior to 
a change in holdings described in paragraph (a)(1)(i) of this section. 
In such a case, the interest of the foundation in such enterprise 
(immediately after such change) shall (while held by the foundation) be 
treated as held by a disqualified person (rather than the foundation) 
during the five-year period beginning on the date of such change, except 
that if and as soon as any holdings in such enterprise become excess 
business holdings during such period (determined without regard to such 
change (and the resulting application of section 4943(c)(6) to the 
foundation's interest in such enterprise)), such holdings shall no 
longer be treated as held by a disqualified person under this section, 
but shall constitute excess business holdings subject to the initial 
tax. In applying the preceding sentence, if holdings of the foundation 
which (but for such change in holdings (and the resulting application of 
section 4943(c)(6) to the foundation's interest in such enterprise)) 
would be subject to the 25 percent limit prescribed by section 
4943(c)(4)(D) after the expiration of the first phase, such holdings 
shall be treated as subject to such percentage limitation for purposes 
of determining excess business holdings. For example, if a private 
foundation in 1978 has present holdings of 28 percent in a busines 
enterprise to which section 4943(c)(4) applies, and such holdings would 
exceed the 25 percent limit of section 4943(c)(4)(D)(i) on May 26, 1979, 
a gift of 5 percent to the foundation in 1978 of an interest in such 
enterprise shall not prevent the 3 percent (28%-25%) excess over the 25 
percent limit from constituting excess business holdings on May 26, 
1979, if on such date disqualified persons hold more than a 2 percent 
interest in such enterprise (and no other transaction has taken place).
    (2) Acquisitions that are not purchases. Section 4943(c)(6) does not 
apply if a change in holdings in a business enterprise is the result of 
a purchase by the private foundation or a disqualified person. For 
purposes of subparagraph (a) of this paragraph, the term ``purchase'' 
shall not include any acquisition by gift, devise, bequest, legacy, or 
interstate succession. Paragraph (d) of this section provides rules for 
the treatment of increases in holdings received in a readjustment (as 
defined in Sec. 53.4943-7(d)(1)).
    (3) Examples. The provisions of paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. On January 4, 1985, A, an individual, makes a 
contribution to F, a private foundation, of 200 shares of X Corporation 
common stock. Assume that F had no X stock before January 4, 1985, and 
under section 4943(c)(1) the receipt of the X stock by F would cause 
some or all of the 200 shares of the X stock to be classified as excess 
business holdings. Under the provisions of section 4943(c)(6)(A) and 
this paragraph (a), since the contribution of the X stock to F is a gift 
and not a purchase, the X stock in F's hands is treated as held by 
disqualified persons and not by F through January 3, 1990.
    Example 2. Assume the facts as stated in Example (1) except that F 
receives the X stock as a bequest pursuant to the terms of A's will 
executed on April 1, 1980. A dies on June 3, 1984, and the stock is 
distributed to F on February 16, 1985. As in Example (1), the

[[Page 137]]

bequest of X to F is not a purchase under this paragraph (a). 
Consequently, the X stock in F's hands is treated as held by 
disqualified persons and not by F through February 15, 1990.
    Example 3. On February 1, 1980, F, a private foundation, owns 15 
percent of the voting stock of X Corporation, and disqualified persons 
own 4 percent of the voting stock of X Corporation. On February 2, 1980, 
B, a nondisqualified person, contributes 8 percent of the voting stock 
of X to F in a transaction to which section 4943(c)(5) does not apply. 
Assuming that the 35 percent limit of section 4943(c)(2)(B) does not 
apply, under the provisions of section 4943(c)(6)(A) and paragraph (a) 
of this section the 23 percent voting stock owned by F on such date is 
treated as held by a disqualified person through February 1, 1985, since 
F would have had excess business holdings of 7 percent as a result of 
the contribution (23% actual holdings less 16% (20%-4%) permitted 
holdings). On March 1, 1984, C, another nondisqualified person, 
contributes 6 percent of the voting stock of X Corporation to F. But for 
this second contribution and the resulting application of section 
4943(c)(6) to F's interest in X, F would have excess business holdings 
of 7 percent (23%-16%) within the five-year period beginning on the date 
of such contribution. Accordingly, under section 4943(c)(6)(B) and 
paragraph (a) of this section, all 29 percent (6%+23%) of the stock held 
by F on March 1, 1984, will be treated as held by a disqualified person 
until March 1, 1989, except that 7 percent will cease to be so treated 
on February 2, 1985. If prior to February 2, 1985, no further 
transactions occurred in the stock of X, F would have excess business 
holdings of 7 percent subject to the initial tax, since the amount still 
treated as held by disqualified persons (29%-7%) plus the amount 
actually held by disqualified persons (4%) already exceed 20 percent.

    (b) Special rules for acquisitions by will or trust--(1) In general. 
In the case of an acquisition of holdings in a business enterprise by a 
private foundation pursuant to the terms of a will or trust, the five-
year period described in section 4943(c)(6) and in this section shall 
not commence until the date on which the distribution of such holdings 
from the estate or trust to the foundation occurs. See Sec. 53.4943-
5(b)(1) for rules relating to the determination of the date of 
distribution under the terms of a will or trust. For purposes of this 
subparagraph, holdings in a business enterprise will not be treated as 
acquired by a private foundation pursuant to the terms of a will where 
the holdings in the business enterprise were not held by the decedent. 
Thus, in the case of after-acquired property, this subparagraph shall 
not apply, the five-year period described in section 4943(c)(6) and this 
section shall commence on the date of acquisition of such holdings by 
the estate, and such five-year period may expire prior to the date of 
distribution of such holdings from the estate. To the extent that an 
interest to which section 4943(c)(6) and this paragraph (b)(1) apply is 
constructively held by a private foundation under section 4943(d)(1) and 
Sec. 53.4943-8 prior to the date of distribution, it shall be treated 
as held by a disqualified person prior to such date by reason of section 
4943(c)(6). See Sec. 53.4943-8 for rules relating to constructive 
holdings held in an estate or trust for the benefit of the foundation.
    (2) Special rule for section 4943(c)(5) interests acquired from a 
nondisqualified person. (i) In the case of holdings of a private 
foundation in a business enterprise to which section 4943(c)(5) 
(relating to certain holdings acquired under a pre-May 27, 1969, will or 
trust) applies which are acquired from a nondisqualified person, the 
interest of the foundation in such enterprise (immediately after such 
acquisition) shall (while held by the foundation) be treated as held by 
a disqualified person (rather than the foundation) under section 
4943(c)(6)(B) and paragraph (a)(1)(iii) of this section from the date of 
acquisition until the end of the fifth year following the date of 
distribution of such holdings. Thereafter, only the holdings to which 
section 4943(c)(5) and Sec. 53.4943-5(a)(1) apply shall continue to be 
treated as held by a disqualified person until the end of the first 
phase with respect thereto.
    (ii) The provisions of paragraph (b)(2)(i) of this section may be 
illustrated by the following examples:

    Example 1. On May 26, 1969, F, a private foundation, owns 5 percent 
of the voting stock of Corporation X and no disqualified persons own any 
stock in X. On June 30, 1977, a nondisqualified person bequeaths to F 33 
percent of the voting stock in X to which section 4943(c)(5) applies. 
This 33 percent interest is distributed to F on August 17, 1978. Under 
section 4943(c)(6)(A) the entire 38 percent (5%+33%) of the X voting 
stock shall be treated as held by a disqualified person from June 30, 
1977 (the date the 33 percent interest

[[Page 138]]

is contructively acquired by F) until August 17, 1983 (five years after 
the date of distribution of the 33 percent interest to F). However, 
assuming that the 35 percent limit of section 4943(c)(2)(B) does not 
apply, the substituted combined voting level on June 30, 1977 is only 33 
percent because there was no interest to which section 4943(c) (4) or 
(5) applied immediately before that date and thus there was no 
substituted combined voting level at that time. In that case, since the 
3-phase holding period is only available for the interest acquired by 
will (33%) under section 4943(c)(5), the substituted combined voting 
level on June 30, 1977 is only 33 percent, not 38 percent. Assuming that 
the substituted combined voting level remains 33 percent at all relevant 
times, and prior to August 17, 1983, no further transactions occur in 
the stock of X, F on that date would have excess business holdings of 5 
percent subject to the initial tax. The amount treated as held by 
disqualified persons at that time (33%) would equal the substituted 
combined voting level at that time (33%), and thus permitted holdings 
would be zero. Under section 4943(c)(5) the 33 percent interest will 
continue to be treated as held by a disqualified person until August 17, 
1988 (10 years after the date of distribution).
    Example 2. On May 26, 1969, F, a private foundation, owns 29 percent 
of the stock (voting power and value) of Corporation X, and on June 30, 
1977, a nondisqualified person bequeaths to F 23 percent of the stock 
(voting power and value) in X to which section 4943(c)(5) does apply. 
This 23 percent interest is distributed to F on August 17, 1978. 
Disqualified persons hold no stock of X. Although the substituted 
combined voting and value levels cannot exceed 50 percent on May 26, 
1979 (at the start of the second phase with respect to the 29 percent 
interest), under section 4943(c)(6)(B) the entire 52 percent (29%+23%) 
of the X voting stock shall be treated as held by a disqualified person 
from June 30, 1977 (the date the 23% interest is constructively acquired 
by F) until August 17, 1983 (five years after the date of distribution 
of the 23% interest to F). On June 1, 1980, during such second phase, D, 
a disqualified person, purchases 3 percent of the X stock (voting power 
and value). On such date, but for the acquisition by F of the 23 percent 
interest, F would have had excess business holdings of 4 percent. The 
purchase by D of more than 2 percent of the voting stock of X causes the 
25 percent limit of section 4943(c)(4)(D)(i) to apply to the 29 percent 
interest (29%-25%=4%). Thus, on June 1, 1980, 4 percent of the X voting 
stock held by F since May 27, 1969, shall cease to be treated as held by 
a disqualified person under section 4943(c)(6)(B) and become excess 
business holdings subject to the initial tax. See Sec. 53.4943-
2(a)(1)(ii) for the 90-day period in which to dispose of these excess 
business holdings resulting from the purchase by the disqualified 
person.

    (c) Exceptions. (1) Section 4943(c)(6) and this section shall not 
apply to any transfer of holdings in a business enterprise by one 
private foundation to another private foundation which is related to the 
first foundation within the meaning of section 4946(a)(1)(H).
    (2) Section 4943(c)(6) and this section shall not apply to an 
increase in the holdings of a private foundation in a business 
enterprise that is part of a plan whereby disqualified persons will 
purchase additional holdings in the same enterprise during the five-year 
period beginning on the date of such change, e.g., to maintain control 
of such enterprise, since such increase shall be treated as caused in 
part by the purchase of such additional holdings.
    (3) The purchase of holdings by an entity whose holdings are treated 
as constructively owned by a foundation, its disqualified persons, or 
both, under section 4943(d)(1) shall be treated as a purchase by a 
disqualified person if the foundation, its disqualified persons or both 
have effective control of the entity or otherwise can control the 
purchase. For example, if a foundation is the beneficiary of a specific 
bequest of $20,000 and its consent is required for the estate to make a 
purchase using such cash, then a purchase by the estate using such cash 
would be treated as a purchase by a disqualified person. Similarly, if 
an executor of an estate is a disqualified person with respect to a 
private foundation, any purchase by the estate would be treated as a 
purchase by a disqualified person.
    (4) If a private foundation, its disqualified persons, or both, hold 
an interest in specific property under the terms of a will or trust, and 
if the private foundation, its disqualified persons, or both, consent or 
otherwise agree to the substitution of holdings in a business enterprise 
for such specific property, such holdings shall be treated as acquired 
by purchase by a disqualified person. For example, if a private 
foundation is the beneficiary of a specific bequest of $20,000 and the 
private foundation agrees to accept certain of the estate's holdings in 
a business enterprise in satisfaction of such

[[Page 139]]

specific bequest, such holdings will be treated as acquired by purchase 
by a disqualified person even if such holdings were held by the 
decedent.
    (d) Readjustments and distributions--(1) General rule. Except as 
otherwise provided in subparagraph (2) of this paragraph, any increase 
in holdings in a business enterprise that is the result of a 
readjustment (as defined in Sec. 53.4943-7(d)(1)) shall be treated as 
acquired other than by purchase. However, holdings that are attributable 
to holdings owned by the private foundation that would have been excess 
business holdings except for the fact that such holdings were treated as 
held by a disqualified person prior to the readjustment shall in no 
event be treated as held by a disqualified person after the date on 
which the holdings to which the change is attributable would have ceased 
to be treated as held by a disqualified person.
    (2) Exceptions. Any increase in holdings in a business enterprise 
that is the result of a readjustment (as defined in Sec. 53.4943-
7(d)(1)), including any change resulting from application of the rule in 
Sec. 53.4943-8(c)(3), shall be treated as occurring by purchase by a 
disqualified person:
    (i) To the extent the increase is attributable to holdings that were 
excess business holdings prior to the readjustment, and separately
    (ii) To the full extent of the increase if the readjustment includes 
a prohibited transaction, unless the foundation establishes to the 
satisfaction of the Commissoner that effective control of all parties to 
the transaction was, at the time of the transaction, in one or more 
persons (other than the foundation) who are not disqualified persons 
with respect to the foundation. See Sec. 53.4943-7(d)(2) for the 
definition of prohibited transaction.
    (3) Section 4943(c)(6) holdings. If, immediately prior to a 
readjustment (as defined in Sec. 53.4943-7(d)(1)), a private foundation 
has holdings in a business enterprise that are treated under section 
4943(c)(6) as held by a disqualified person, then any holdings in a 
business enterprise that are received in the readjustment in exchange 
for such section 4943(c)(6) holdings shall be treated as the holdings 
surrendered in the exchange to the same extent as provided in Sec. 
53.4943-7 with respect to exchanges involving holdings to which section 
4943(c) (4) or (5) applies. Rules similar to those in Sec. 53.4943-
7(a)(2) shall be applied to determine when holdings are treated as 
surrendered or received in a readjustment for purposes of this 
paragraph.
    (4) Redemption by a corporation that is a disqualified person. If a 
foundation holds an interest in a corporation that is a disqualified 
person, an increase in the holdings of the private foundation, its 
disqualified person, or both, as a result of a redemption or a purchase 
of stock of the disqualified person corporation by such corporation 
shall not be treated as acquired by purchase by a disqualified person 
based solely on the status of the corporation as a disqualified person.
    (5) One percent rule for redemptions. If the holdings of a 
foundation, its disqualified persons, or both, in a business enterprise 
are increased as a result of one or more redemptions during any taxable 
year then, unless the aggregate of such increases equals or exceeds one 
percent of the outstanding voting stock or one percent of the value of 
all outstanding shares of all classes of stock, the determination of 
whether such increases cause the foundation to have excess business 
holdings shall be made only at the close of the private foundation's 
taxable year. The five-year period described in section 4943(c)(6) or 
the 90-day period described in Sec. 53.4943-2(a)(1)(ii), whichever is 
applicable, shall begin on the last day of such taxable year. If, 
however, the aggregate of such increases equals or exceeds one percent 
of the outstanding voting stock or one percent of the value of all 
outstanding shares of all classes of stock, the determination of whether 
such increases cause the foundation to have excess business holdings 
shall be made, and the applicable five-year or 90-day period shall 
begin, as of the date the increases, in the aggregate, equal or exceed 
one percent.
    (6) Examples. The provisions of this paragraph are illustrated in 
Sec. 53.4943-7(f) and by the following examples:

    Example 1. (i) F, a private foundation, holds 20% of the voting 
stock of X corporation, an active business enterprise. No disqualified

[[Page 140]]

person with respect to F holds any X stock. In 1980, X redeems 10% of 
its outstanding shares, increasing F's holdings to 22% of the X stock. 
Assume the redemption by X is not a prohibited transaction.
    (ii) All of F's holdings before the redemption are permitted 
holdings under section 4943(c)(2). There is no effective control of X by 
third parties so the 35% permitted holdings rule is inapplicable. F's 
holdings after the redemption exceed the permitted holdings under 
section 4943 (c)(2) (20%). Because the increase is attributable to stock 
that was permitted holdings prior to the readjustment, and the 
readjustment does not involve a prohibited transaction, the 2% increase 
in F's holdings of X stock is treated as acquired other than by 
purchase. Therefore, under section 4943(c)(6) and this section, F will 
have 5 years from the date of the redemption to dispose of the 2% 
excess.
    Example 2. (i) Assume the same facts as in Example (1) except that 
the 20% of X stock held by F was donated by X corporation, was worth 
more than $5,000 and represented 20% of the contributions received by 
the foundation through the end of the taxable year in which the gift of 
stock was made.
    (ii) X corporation is a disqualified person with respect to F under 
section 4946(a)(1)(A). Under subparagraph (4), the redemption of X stock 
is not treated as a purchase by a disqualified person merely because X 
is a disqualified person with respect to F. Therefore the rules of this 
paragraph apply as if the redemption were made by a corporation which is 
not a disqualified person. The analysis and result are the same as in 
Example (1).
    Example 3. (i) On May 1, 1990, F, a private foundation, received a 
donation of 40% of the stock of X corporation, a business enterprise. 
Neither F nor any disqualified person with respect to F holds any other 
interest in X. On June 1, 1992, the X corporation redeemed F's 40% 
interest in exchange for 100% of the stock of Y corporation, a wholly-
owned subsidiary of X. Assume the redemption by X is not a prohibited 
transaction.
    (ii) Under section 4943(c)(6), the X stock acquired by gift is 
treated as held by disqualified persons through April 30, 1995. Under 
subparagraph (3) of this paragraph (d), 40% of the 100% interest in Y 
received in exchange for F's 40% interest in X is treated as F's 40% 
interest in X and is therefore treated as held by disqualified persons 
through April 30, 1995. In addition, under subparagraph (1) of this 
paragraph (d), the 60% interest in Y that represents an increase in 
holdings above the 40% held before the readjustment will be treated as 
acquired other than by purchase. However, F's 20% interest in X in 
excess of 20% permitted holdings under 4943(c)(2) would have been excess 
business holdings if such interest had not been treated as held by as 
disqualified person on June 1, 1992. Therefore, to the extent of a 30% 
interest in Y, (i.e., the portion of the increased holdings in Y 
attributable to F's 20% holdings in X) the increased holdings will be 
treated as held by disqualified person only through April 30, 1995, 
since this is the latest date on which F's original 40% interest in X 
would have been treated as held by disqualified persons. The remaining 
30% interest in Y will be treated as held by disqualified persons for 
five years from the date of the exchange (through May 31, 1997).

    (e) Constructive holdings. Any change in holdings in a business 
enterprise that occurs because a corporation ceases to be actively 
engaged in a trade or business, thus causing its holdings to be 
constructively owned by its shareholders, shall be treated as acquired 
other than by purchase.
    (f) Certain transactions treated as purchases; cross references. For 
the application of section 4943(c)(6) to holdings that were not an 
interest in a business enterprise when acquired but that subsequently 
become holdings in a business enterprise, see Sec. 53.4943-10(d)(2).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6479, Feb. 22, 1984]



Sec. 53.4943-7  Special rules for readjustments involving grandfathered holdings.

    (a) General rules--(1) Readjustments. Except to the extent provided 
in paragraph (b) of this section, if a private foundation, its 
disqualified persons, or both together have holdings in a corporation to 
which section 4943(c) (4) or (5) applies, stock of a corporation 
received by the foundation, its disqualified persons, or both together 
in a readjustment (as defined in paragraph (d)(1) of this section) in 
exchange for such holdings to which section 4943 (c) (4) or (5) applies 
shall be treated, for purposes of section 4943 (c) (4) or (5), as the 
stock surrendered in the exchange.
    (2) No exchange necessary. Paragraph (a)(1) of this section shall 
apply to all readjustments even if no exchange occurs. For purposes of 
this section, all stock held (directly or indirectly) before a 
readjustment in any corporation involved in the readjustment shall be 
treated as stock surrendered in the readjustment and all stock held 
(directly or indirectly) after the readjustment in

[[Page 141]]

any corporation involved in the readjustment shall be treated as stock 
received in the readjustment in exchange for the stock treated as 
surrendered.
    (b) Exceptions and limitations--(1) Limitation on increases in 
percentage of voting stock. (i) If the percentage of voting stock in a 
business enterprise owned (directly or indirectly) by a private 
foundation by reason of its ownership of stock received in an exchange 
described in paragraph (a) of this section exceeds the greatest 
percentage of voting stock in any business enterprise owned (directly or 
indirectly) by the private foundation prior to such exchange by reason 
of its ownership of the stock surrendered by it in the exchange, then:
    (A) That portion of the stock received by the private foundation in 
the exchange which represents such excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6 (d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange shall be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If the sum of the percentage of voting stock in a business 
enterprise owned (directly or indirectly) by disqualified persons by 
reason of their ownership of stock received in an exchange described in 
paragraph (a) of this section plus the percentage of voting stock in the 
business enterprise owned (directly or indirectly) by the private 
foundation by reason of its ownership of stock received in the exchange 
and treated as the stock surrendered under paragraph (b) (1) (i) of this 
section exceeds the greatest percentage of voting stock in any business 
enterprise owned (directly or indirectly) by the private foundation and 
its disqualified person in combination by reason of their ownership of 
the stock surrendered by them in the exchange, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange which represents such excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the 
disqualified persons in the exchange is to be treated as the stock 
surrendered by the disqualified persons in the exchange.
    (2) Limitation on increase in percentage of value. (i) If the 
percentage of value of all outstanding shares of all classes of stock in 
a business enterprise owned (directly or indirectly) by a private 
foundation by reason of its ownership of stock received in an exhange 
described in paragraph (a) of this section exceeds the greatest 
percentage of such value in any business enterprise owned (directly or 
indirectly) by the private foundation prior to such exchange by reason 
of its ownership of the stock surrendered by it in the exchange, then:
    (A) That portion of the stock received by the private foundation in 
the exchange which represents such excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange shall be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If the sum of the percentage of value of all outstanding shares 
of all classes of stock in a business enterprise owned (directly or 
indirectly) by disqualified persons by reason of their ownership of 
stock received in an exchange described in paragraph (a) of this section 
plus the percentage of such value in the business enterprise owned 
(directly or indirectly) by the private foundation by reason of its 
ownership of stock received in the exchange and treated as the stock 
surrendered under paragraph (b)(2)(i) of this section exceeds the 
greatest percentage of such value in any business enterprise owned 
(directly or indirectly) by the private foundation and its disqualified 
persons in combination prior to the exchange by reason of their 
ownership of the stock surrendered by them in the exchange, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange which represents such excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the 
disqualified persons in the exchange is to be treated as

[[Page 142]]

the stock surrendered by the disqualified persons in the exchange.
    (3) Increases in percentage of both voting stock and value. (i) If, 
as the result of an exchange described in paragraph (a) of this section, 
a private foundation has excesses determined under both paragraphs 
(b)(1)(i) and (b)(2)(i) of this section, then:
    (A) That portion of the stock received by the private foundation in 
the exchange that represents the larger excess is to be treated as an 
increase in the holdings of the private foundation in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by the private 
foundation in the exchange is to be treated as the stock surrendered by 
the private foundation in the exchange.
    (ii) If as the result of an exchange described in paragraph (a) of 
this section, disqualified persons have excesses determined under both 
paragraphs (b)(1)(ii) and (b)(2)(ii) of this section, then:
    (A) That portion of the stock received by the disqualified persons 
in the exchange that represents the larger excess is to be treated as an 
increase in the holdings of the disqualified persons in accordance with 
Sec. 53.4943-6(d), and
    (B) Only the remaining portion of the stock received by disqualified 
persons in the exchange is to be treated as the stock surrendered by 
disqualified persons in the exchange.
    (4) Exception for prohibited transactions. If a readjustment 
includes a prohibited transaction, as defined in paragraph (d)(2) of 
this section, then this paragraph shall be applied substituting, for 
purposes of paragraph (b)(1) and (b)(2), the lowest percentage of voting 
power or value owned prior to the exchange in any business enterprise 
involved in the readjustment to which the exchange relates for the 
greatest percentage of voting power or value in any business enterprise 
owned by reason of ownership of the stock surrendered in the exchange.
    (5) Voting and value levels. After an exchange described in 
paragraph (a) of this section, the private foundation voting and value 
levels, and the substituted combined voting and value levels (as defined 
in Sec. 53.4943-4(d)(2)) shall be the lesser of each respective level 
immediately prior to the exchange with respect to the stock surrendered 
in the exchange and each such respective level determined immediately 
after the exchange by taking into account only the stock received in the 
exchange that is treated under this paragraph as the stock surrendered 
in the exchange. If the stock of more than one corporation is 
surrendered in exchange for stock of one corporation, the highest of 
each voting or value level determined immediately prior to the exchange 
with respect to the stock of the corporations surrendered in the 
exchange shall be treated as such level immediately prior to the 
exchange.
    (6) Determination of phases--(i) In general. Stock received in an 
exchange described in paragraph (a) of this section that is treated as 
stock surrendered in the exchange under this paragraph shall be treated 
as subject to the same first, second, and third phases that were 
applicable to the stock surrendered for it. For purposes of determining 
the applicable phases, stock received in an exchange shall be treated as 
received in exchange for particular holdings of stock surrendered based 
on the terms of the exchange. Where only a portion of the stock received 
is treated as the stock surrendered, such portion of the stock received 
shall be treated as exchanged for particular holdings of stock 
surrendered in the same proportions as the total stock received was 
exchanged for particular holdings of stock surrendered. For example, if 
20 shares of X stock owned by a private foundation, subject to a first 
phase beginning on January 1, 1978 and ending on December 31, 1987, are 
exchanged for 20 shares of Y stock, and 40 shares of X stock owned by 
the private foundation, subject to a first phase beginning on June 1, 
1980 and ending on May 31, 1990, are exchanged for 40 shares of Y stock, 
then \1/3\ of the Y stock received by the private foundation is treated 
as received in exchanged for X stock having the January 1, 1978-December 
31, 1987 first phase and \2/3\ of the Y stock received by the private 
foundation is treated as received in exchange for the X stock having the 
June 1, 1980-May 31, 1990 first phase. If only 30 shares of the Y stock 
received by the private foundation are treated as the

[[Page 143]]

stock surrendered, then \1/3\ (10 Y shares) will be subject to the 
January 1, 1978-December 31, 1987 first phase and \2/3\ (20 Y shares) 
will be subject to the June 1, 1980-May 31, 1990 first phase.
    (ii) Transitional rule. In any case in which holdings subject to 
section 4943(c)(4) or 4943(c)(5) have been consolidated prior to May 22, 
1984, then the longest first phase applicable to any of the holdings 
surrendered in the consolidation shall be applied to the holdings 
received by the foundation in the consolidation that are treated as the 
holdings surrendered in the consolidation. For purposes of this clause, 
a consolidation is any readjustment that results in a reduction in the 
number of entities in which the foundation has direct holdings.
    (c) Plan to dispose of excess business holdings. (1) Notwithstanding 
Sec. 53.4943-4(d)(i)(4)(D) (relating to restrictions on increases in 
levels) and paragraphs (a) and (b) of this section, if a readjustment 
occurs under an approved plan to dispose of stock to which section 
4943(c) (4) or (5) applies, in order to meet the requirements of section 
4943(c)(4) (i.e., to meet the reduced limits that will be applicable 
after the first phase holding period described in Sec. 53.4943-4(c)) or 
to meet the requirements of section 4943(c)(2), all of the stock 
received in the readjustment shall be treated as held by disqualified 
persons through the end of the longest first phase holding period 
applicable to stock surrendered in the readjustment. The foundation and 
substituted combined voting and value levels shall not be increased on 
account of the readjustment.
    (2) For purposes of this paragraph, a plan is an approved plan only 
if it is approved by the Commissioner and may be subject to such 
conditions as the Commissioner determines. A plan must be approved prior 
to any exchange or distribution pursuant to the plan except for a 
showing of good cause such as a business emergency.
    (d) Definitions--(1) Readjustments. For purposes of this section, 
the term ``readjustment'' includes, but is not limited to:
    (i) A merger or consolidation;
    (ii) A recapitalization;
    (iii) An acquisition of stock or assets;
    (iv) A transfer of assets;
    (v) A change in identity, form, or place of organization, however 
effected;
    (vi) A redemption;
    (vii) A distribution of assets or of stock, including a distribution 
to which section 301, 302, 331, or 355 applies or a distribution of 
stock of the distributing corporation.
    (2) Prohibited transaction. A prohibited transaction is any 
transaction involving a private foundation that has holdings in a 
business enterprise which:
    (i) Acquires stock (or similar interest in the case of an 
unincorporated entity) or assets of a business enterprise or redeems its 
own stock (or similar interest in the case of an unincorporated entity) 
using cash or other property transferred to the acquiring business 
enterprise (e.g., as a contribution to capital) by the private 
foundation, its disqualified persons, or both;
    (ii) Acquires stock (or similar interest in the case of an 
unincorporated entity) or assets of a business enterprise or redeems its 
own stock (or similar interest in the case of an unincorporated entity) 
using the proceeds of a loan made to, or guaranteed by, the private 
foundation, its disqualified persons, or both;
    (iii) Acquires 40 percent or more of the voting stock (or similar 
interest in the case of an unincorporated entity), 40 percent or more of 
the value of all outstanding shares of all classes of stock (or similar 
interest in the case of an unincorporated entity), or 40 percent or more 
of the assets of a business enterprise if the acquiring business 
enterprise's net assets used in its trade or business prior to such 
acquisition are insubstantial when compared to the net assets acquired 
or when compared to the net assets of the business enterprise, the stock 
(or similar interest in the case of an unincorporated entity) of which 
was acquired. For this purpose, an insubstantial ratio means a ratio 
that is 15% or less; or
    (iv) Is used as a device to acquire or expand excess business 
holdings. The determination of whether a business enterprise is used as 
a device to acquire or expand excess business holdings shall be 
determined based on all the

[[Page 144]]

facts and circumstances. A business enterprise shall be presumed to have 
been used as a device to acquire or expand excess business holdings if 
it acquires 40 percent or more of the voting stock (or similar interest 
in the case of an unincorporated entity), 40 percent or more of the 
value of all outstanding shares of all classes of stock (or similar 
interest in the case of an unincorporated entity), or 40 percent or more 
of the assets of a business enterprise if the consideration for the 
acquisition consists primarily of nonvoting stock (or similar interest 
in the case of an unincorporated entity) of the acquiring business 
enterprise.
    (3) Corporation involved in a readjustment. A corporation shall be 
treated as involved in a readjustment if, as part of the readjustment, 
any stock of the corporation is issued or redeemed, or any stock or 
assets of the corporation are distributed, exchanged, purchased, sold, 
acquired, or otherwise transferred.
    (e) Application to unincorporated business enterprise. The rules of 
this section shall apply equally to partnerships and other 
unincorporated business enterprises, applying the rules and 
substitutions provided in Sec. 53.4943-3(c)(2), (3), and (4).
    (f) Examples. The provisions of this section and Sec. 53.4943-6(d) 
are illustrated by the following examples, which assume no prohibited 
transactions are involved unless otherwise stated:

    Example 1. (i) F, a private foundation, has owned 80% of the one 
outstanding class of stock of X corporation since 1965. The X is subject 
to section 4943(c)(4) with a first phase ending on May 25, 1984. On 
January 1, 1982, X merges with Y corporation to form Z corporation. X, 
Y, and Z are active business corporations. F owns no Y stock. No 
disqualified person with respect to F owns any stock in Y.Y, or Z. After 
the merger, F owns 25% of the one outstanding class of Z stock. Third 
parties do not control Z so that the 35% permitted holdings rule under 
section 4943(c)(2) is inapplicable
    (ii) F's percentage of voting power and value in Z after the merger 
(25%) are less than F's percentages of voting power and value in X 
before the merger (80%). Therefore, under paragraph (a)(1) of this 
section, all of F's holdings in Z are treated as the X stock 
surrendered. Therefore, the Z stock is treated as subject to section 
4943(c)(4) with a first phase ending on May 25, 1984. Under downward 
ratchet of paragraph (a)(5) of this section, the foundation voting and 
value levels and the substituted combined voting and value levels are 
reduced to 25%.
    Example 2. (i) F, a private foundation, owns 100% of the one 
outstanding class of stock in X corporation and 30% of the one 
outstanding class of stock in Y corporation. F has held this stock 
continuously since 1960, and no disqualified person has even owned any 
stock in X or Y. Under section 4943(c)(4), F's holdings in X are treated 
as held by disqualified persons through the end of the first phase on 
May 25, 1989, and F's holdings in Y are permitted holdings during the 
second phase, which began on May 25, 1989, and F's holdings in Y are 
permitted holdings during the second phase, which began on May 26, 1979. 
On January 1, 1985, X and Y consolidate, forming a new corporation Z. In 
the consolidation, F acquires 50% of the one class of outstanding stock 
of Z, 40% in exchange for F's 100% interest in X and 10% in exchange for 
F's 30% interest in Y. Unrelated parties hold the remaining 50% of Z.
    (ii) F's percentage of voting power and value in Z after the merger 
(50%) are less than F's percentages of voting power and value in X 
before the merger (100%). Thus, under paragraph (a)(1) of this section, 
the 50% interest in Z held by F is treated as the stock surrendered in 
the exchange for purposes of section 4943(c)(4). Under paragraph (b)(6) 
of this section, the 10% interest in Z received for the Y stock is 
subject to the same second phase period as the surrendered Y stock. The 
40% interest first phase period as the surrendered X stock.
    Example 3. (i) F, a private foundation, owns 50% of the one class of 
outstanding stock in X corporation which F has held continuously since 
1935. No disqualified person with respect to F owns any stock in X. 
Neither F nor any disqualified person with respect to F owns any stock 
in Y corporation. On July 1, 1982, X and Y enter into an agreement to 
consolidate their businesses in a reorganization to which section 
368(a)(1)(A) will apply. As a result of the contemplated consolidation, 
F will own 60% of the voting stock in Z, the resulting corporation. In 
addition, parties unrelated to F will own the remaining 40% of the Z 
voting stock and 100% of a new issue of nonvoting preferred stock in Z. 
Assume for purposes of this example, that the 60% of the voting stock to 
be held by F in Z will represent 50% of the fair market value of the 
outstanding Z stock.
    (ii) Under the provisions of paragraph (b)(1) of this section, that 
portion of the Z stock held by F which represents a percentage of voting 
power equivalent to that held by F in X immediately prior to the 
consolidation (i.e., 50%) will be treated as the X stock held by F on 
May 26, 1969, for purposes of section 4943(c)(4). Therefore, 50% of the 
Y stock will

[[Page 145]]

be treated as subject to a second phase ending on May 25, 1994. The 
remaining portion of the Z voting stock held by F (10%) is subject to 
the provisions of Sec. 53.4943-6(d)(1). F will have five years from the 
date of the merger in which to dispose of 10% of the Z stock without 
incurring the tax on excess business holdings.
    Example 4. (i) F, a private foundation, owns 80% of the one class of 
outstanding stock in X corporation, an active business corporation. F 
has held this stock continuously since 1960 and no disqualified person 
with respect to F owns any stock in X. X has two operating divisions, 
one which manufacturers shoes and the other which manufactures 
refrigerators. On January 1, 1978, in a section 351(a) exchange, X 
transferred all of the assets of its shoe manufacturing division to Y, a 
corporation which X has formed for this purpose, and receives 100% of 
the stock of Y so that Y is a wholly-owned subsidiary of X. X then 
transfers all of the Y stock to F in exchange for all of F's holdings of 
X stock in a distribution to which section 355 applies.
    (ii) Under paragraph (b)(1) of this section, 80% of the Y stock is 
treated as the X stock surrendered in the exchange for purposes of 
section 4943(c)(4). The 80% is treated under Sec. 53.4943-4(c) as held 
by disqualified persons through May 25, 1984, which constitutes the 15-
year first phase holding period applicable to the 80% holding in X. The 
80% of the Y stock must be reduced to the permitted holdings allowed 
during the second and third phase as provided by section 4943(c)(4)(D) 
in the same manner as F's holdings of X stock would have had to have 
been reduced.
    (iii) Under Sec. 53.4943-6(d)(1), the remaining 20% of Y stock is 
treated as held by a disqualified person for five years from the date of 
the exchange. F will have five years from the date of the exchange in 
which to dispose of 20% of the Y stock without incurring the tax on 
excess business holdings.
    Example 5. (i) X corporation, an active business corporation, has 
outstanding 1,000 shares of one class of stock, of which 600 shares have 
been held by F1, a private foundation; 100 shares have been held by F2, 
another private foundation; and 100 shares have been held by D, a 
disqualified person with respect to both F1 and F2. Unrelated parties 
hold the remaining 200 shares. F1 and F2 are disqualified persons with 
respect to each other under section 4946(a)(1)(H). Thus, F1 holds 60% of 
the X stock (600/1000); F2 and D each hold 10% (100/1000); and the 
foundation group (F1, F2 and D) holds 80% of X (800/1000). The holdings 
of F1 and F2 were acquired on January 1, 1980 pursuant to a pre-1969 
will and are subject to section 4943(c)(5). There have been no changes 
in holdings since January 1, 1980.
    (ii) On January 1, 1985, pursuant to a plan to dispose of excess 
business holdings approved by the Commissioner under paragraph (c) of 
this section, X redeems for cash the 600 shares held by F1. After the 
redemption, D and F2 each hold 25% of X (100/400). F1 no longer holds 
any X stocks. The foundation group's holdings (F1, F2 and D) have 
decreased from 80% to 50% while holdings of unrelated parties have 
increased from 20% to 50%. At the same time F2's and D's holdings each 
have increased from 10% to 25%.
    (iii) Notwithstanding the increase in F2's and D's holdings, under 
paragraph (c) of this section, all of the X stock held by F2 will be 
treated as held by a disqualified person through the end of the first 
phase (December 31, 1994). However, the foundation voting and value 
levels do not increase. Therefore, after the end of the first phase, 
F2's holdings in X may not exceed 10 percent (if the combined holdings 
of F1, F2 and D exceed the permitted holdings under section 4943(c)(2)).
    Example 6. (i) X corporation, an active business corporation, has 
outstanding 1,000 shares of its one class of stock. Since 1960, 100 
shares (10%) have been held by F, a private foundation and 350 shares 
(35%) have been held by D, a disqualified person with respect to F. All 
of the stock held by F is permitted holdings under section 4943(c)(4) 
and the substituted combined voting and value levels are 45% (10% + 
35%). Because of disagreements concerning management of X between D and 
A, an unrelated party who holds 300 shares (30%) of the X stock, X 
redeems all of A's shares on December 1, 1981.
    (ii) After the redemption, F holds 14.3% (100/700) of the X stock 
and D holds 50% (350/700), for combined holdings of 64.3%. Because the 
combined holdings exceed the substituted combined voting level (45%) by 
more than F's entire holdings, all of the F stock is excess business 
holdings. However, all of F's stock will be treated as acquired other 
than by purchase under Sec. 53.4943-6(d)(1) and therefore will be 
treated under section 4943(c)(6) and this section, as held by a 
disqualified person for five years from the date of the redemption 
(through November 30, 1986). If the combined holdings of F and its 
disqualified person are reduced to 45 percent by the end of the five 
year period, F may retain a portion of its holdings in X (limited to no 
more than the foundation voting and value level of 10 percent).
    Example 7. Assume the same facts as in Example (6), except that D 
loaned the money to X that was used to redeem A's shares. Under these 
facts, the increased holdings result from a prohibited transaction 
described in paragraph (d)(2) of this section. Therefore, all of F's 
stock will be treated as acquired by purchase by a disqualified person 
under Sec. 53.4943-6(d)(2). F will have 90 days after the redemption in 
which to dispose of its holdings or to reduce its holdings and the 
combined holdings to the levels held prior to the redemption as 
discussed in Example (6).

[[Page 146]]

    Example 8. (i) F, a private foundation, has held 100% of the 
outstanding stock of X corporation since 1960. F also holds 15% of the 
voting stock of Y corporation. Both X and Y are active business 
corporations. X has $1 million in net assets used in its trade or 
business and Y has $6.7 million used in its trade or business. On June 
1, 1985, Y is merged into X. After the merger F holds 25% of the voting 
stock of X. No person other than F controls X after the merger.
    (ii) Because more than 40% of Y was acquired and the net assets of 
X, the acquiring corporation, used in its trade or business prior to the 
merger represent less than 15% of the net assets of Y used in its trade 
or business, the merger is a prohibited transaction described in 
paragraph (d)(2)(iii). Therefore, only 15% of the stock X is treated, 
pursuant to paragraph (b), as the stock held by F prior to the 
redemption. F's holding of 5% (the excess of F's 25% holdings over the 
20% permitted holdings in X (determined under section 4943(c)(2)) are 
treated as purchased by a disqualified person pursuant to Sec. 53.4943-
6(d)(2). F will have 90 days after June 1, 1985, in which to dispose of 
the 5% excess holdings.

[T.D. 7944, 49 FR 6480, Feb. 22, 1984]



Sec. 53.4943-8  Business holdings; constructive ownership.

    (a) Constructive ownership--(1) In general. For purposes of section 
4943, in computing the holdings in a business enterprise of a private 
foundation, or a disqualified person (as defined in section 4946), any 
stock or other interest owned, directly or indirectly, by or for a 
corporation, partnership, estate or trust shall be considered as being 
owned proportionately by or for its shareholders, partners, or 
beneficiaries except as otherwise provied paragraphs (b), (c) and (d) of 
this section. Any interest in a business enterprise actually or 
constructively owned by a shareholder of a corporation, a partner of a 
partnership, or beneficiary of an estate or trust shall not be 
considered as constructively held by the corporation, partnership, trust 
or estate. Further, if any corporation, partnership, estate or trust has 
a warrant or other option to acquire an interest in a business 
enterprise, such interest is not deemed to be constructively owned by 
such entity until the option is exercised. (See paragraph (b)(2) of 
Sec. 53.4943-3 for rules that options are not stock for purposes of 
determining excess business holdings.)
    (2) Powers of appointment. Any interest in business enterprise over 
which a foundation or a disqualified person has a power of appointment 
exercisable in favor of the foundation or a disqualified person shall be 
considered owned by the foundation or disqualified person holding such 
power of appointment.
    (3) Determination of extent of constructive ownership. If an 
interest in a business enterprise owned by a corporation is 
constructively owned by a shareholder, each shareholder's proportion of 
ownership is generally computed on the basis of the voting stock each 
shareholder has in the corporation. In determining holdings permitted 
under section 4943(c) (4) and (5), each shareholder's proportion of 
ownership in the business enterprise shall also be computed on the basis 
of value, taking into account both voting and nonvoting stock held by 
the shareholder.
    (4) Nonvoting stock. If a private foundation, its disqualified 
persons, or both, own (directly or constructively) nonvoting stock of a 
parent corporation, the holdings of which are treated as constructively 
owned by its shareholders by reason of section 4943(d)(1) and this 
section, such nonvoting stock shall be treated as nonvoting stock of any 
corporation in which the parent corporation holds an interest for 
purposes of the limitation on the holding of nonvoting stock under 
section 4943(c)(2)(A) and Sec. 53.4943-3(b)(2).
    (5) Interests held by certain disqualified persons. In the case of 
an entity that is a disqualified person (other than an entity described 
in section 4946(a)(1)(H)), the holdings of which are treated as 
constructively owned by its shareholders, partners, or beneficiaries, 
for purposes of determining the total holdings of disqualified persons 
the holdings of the entity shall be considered held by a disqualified 
person only to the extent such holdings are treated as constructively 
owned by disqualified persons who are shareholders, partners, or 
beneficiaries of the entity. In the case of an entity described in 
section 4946(a)(1)(H) or an entity, the holdings of which are not 
treated as constructively owned by its shareholders, partners, or 
beneficiaries, all holdings of such entity shall be treated as held by

[[Page 147]]

a disqualified person if and only if the entity itself is a disqualified 
person.
    (b) Estates and trusts--(1) In general. Any interest actually or 
constructively owned by an estate or trust is deemed constructively 
owned, in the case of an estate, by its beneficiaries or, in the case of 
a trust, by its remainder beneficiaries except as provided in paragraphs 
(b) (2), (3) and (4) of this section (relating to certain split-interest 
trusts described in section 4947(a)(2), to trusts of qualified pension, 
profit-sharing, and stock bonus plans described in section 401(a) and to 
revocable trusts). Thus, if a trust owns 100 percent of the stock of a 
corporation A, and if, on an actuarial basis, W's life interest in the 
trust is 15 percent, Y's life interest is 25 percent, and Z's remainder 
interest is 60 percent, under this paragraph (b), Z will be considered 
to be the owner of 100 percent of the stock of corporation A. See Sec. 
53.4943-4, Sec. 53.4943-5 and Sec. 53.4943-6 for rules relating to 
certain actual or constructive holdings of a foundation being treated as 
held by a disqualified person. For the treatment of certain property 
acquired by an estate or trust after May 26, 1969, see paragraph (a)(2) 
of Sec. 53.4943-5.
    (2) Split-interest trusts--(i) Amounts transferred in trust after 
May 26, 1969. In the case of an interest in a business enterprise which 
was transferred to a trust described in section 4947(a)(2) after May 26, 
1969, for the benefit of a private foundation, no portion of such 
interest shall be considered as owned by the private foundation:
    (A) If the foundation holds only an income interest in the trust, or
    (B) If the foundation holds only a remainder interest in the trust 
(unless the foundation can exercise primary investment discretion with 
respect to such interest)

until such trust ceases to be so described. See section 4947(a)(2) and 
(b)(3) and the regulations thereunder for rules relating to such trusts. 
See also sections 4946(a)(1) (G) and (H) and the regulations thereunder 
for rules relating to when a trust described in this paragraph (b)(2) is 
itself a disqualified person.
    (ii) Amounts transferred in trust on or before May 26, 1969. In the 
case of an interest in a business enterprise which was transferred to a 
trust described in section 4947(a)(2) (without regard to section 
4947(a)(2)(C)) on or before May 26, 1969, for the benefit of a private 
foundation, no portion of such interest shall be considered as owned by 
the foundation until it is actually distributed to the foundation or 
until the trust ceases to be so described. See section 4943(c)(5) and 
Sec. 53.4943-5 for rules relating to certain trusts which were 
irrevocable on May 26, 1969.
    (3) Employee benefit trusts. An interest in a business enterprise 
owned by a trust described in section 401(a) (pension and profit-sharing 
plans) shall not be considered as owned by its beneficiaries, unless 
disqualified persons (within the meaning of section 4946) control the 
investment of the trust assets.
    (4) Revocable trusts. An interest in a business enterprise owned by 
a revocable trust shall be treated as owned by the grantor of such 
trust.
    (5) Estates. For purposes of applying section 4943(d)(1) to estates, 
the term ``beneficiary'' includes any person (including a private 
foundation) entitled to receive property of a decedent pursuant to a 
will or pursuant to laws of descent and distribution. However, a person 
shall no longer be considered a beneficiary of an estate when all the 
property to which he is entitled has been received by him, when he no 
longer has a claim against the estate and when there is only a remote 
possibility that it will be necessary for the estate to seek the return 
of property or to seek payment from him by contribution or otherwise to 
satisfy claims against the estate or expenses of administration. When 
pursuant to the preceding sentence, a person (including a private 
foundation) ceases to be a beneficiary, stock or another interest in a 
business enterprise owned by the estate shall not thereafter be 
considered owned by such person. If any person is the constructive owner 
of an interest in a business enterprise actually held by an estate, the 
date of death of the testator or decedent intestate shall be the first 
day on which such person shall be considered a constructive owner of 
such interest. See Sec. 53.4943-5 for rules relating to wills executed 
on or before May 26, 1969.

[[Page 148]]

    (c) Corporation actively engaged in a trade or business--(1) In 
general. Except as provided in paragraphs (c)(2) and (3) of this 
section, any interest (whether or not in a separate entity) owned by a 
corporation which is actively engaged in a trade or business shall not 
be deemed to be constructively owned by such corporation's shareholders.
    (2) Actively engaged in a trade or business. For purposes of 
paragraph (c)(1) of this section:
    (i) A corporation shall not be considerd to be actively engaged in a 
trade or business if the corporation is not a business enterprise by 
reason of section 4943(d)(3) (A) or (B) and Sec. 53.4943-10 (b) or (c);
    (ii) In the case of a corporation which owns passive holdings and is 
actively engaged in a trade or business, such corporation shall not be 
considered to be actively engaged in a trade or business if the net 
assets used in such trade or business are insubstantial when compared to 
passive holdings.
    (3) Exceptions. If a corporation has been involved in a prohibited 
transaction, any interest in a business enterprise owned by such 
corporation shall be treated as constructively owned by its 
shareholders, whether or not such corporation is actively engaged in a 
trade or business. For a definition of prohibited transaction, see Sec. 
53.4943-7 (d)(2).
    (4) Affiliated group. In applying this paragraph to the common 
parent in an affiliated group (as defined in Sec. 53.4943-10 
(c)(3)(ii)), the assets and activities of the affiliated group shall be 
treated as the assets and activities of the common parent.
    (d) Partnerships. Any interest in a business enterprise which is 
owned by a partnership shall be deemed to be constructively owned by the 
partners in such partnerships.
    (e) Examples. The provisions of this section are illustrated by the 
following examples.

    Example 1. F, a private foundation, directly owns voting stock of X, 
a holding company described in section 4943(d)(3)(B). That stock 
represents 40% of the voting power in X and 20% of the value of all 
outstanding shares of all classes of stock in X. F also owns nonvoting 
stock in X that represents 10% of the value of all outstanding shares of 
all classes of stock in X. D, a disqualified person, owns voting stock 
of X that represents 40% of the voting power in X and 20% of the value. 
D does not own any nonvoting stock in X. X corporation's only holding is 
stock of Y corporation. The Y voting stock held by X represents 50% of 
the voting power in Y and 25% of the value of all outstanding shares of 
all classes of stock in Y. X also owns nonvoting stock in Y that 
represents 25% of the value of all outstanding shares of all classes of 
stock in Y. Under paragraph (a)(3) of this section, F and D each 
constructively owns 20% of the voting power in Y through their voting 
interest in X (40% of X's 50% of Y). F also constructively owns 15% of 
the value of all outstanding shares of all classes of stock in Y through 
F's interest in X (F's 30% of the value of X multiplied by X's 50% of 
the value of Y), while D constructively owns 10% of the value of Y (D's 
20% of the value of X multiplied by X's 50% of the value of Y).
    Example 2. (i) F, a private foundation, owns 50% of the one class of 
nonvoting stock of X corporation, a corporation described in section 
4943(d)(3)(B) and paragraph (c)(2)(i) above. D, a disqualified person 
with respect to F as described in section 4946(a)(1)(A), owns 40% of the 
one class of voting stock of X. X corporation is a disqualified person 
with respect to F because D owns more than 35% of the voting of X. (See 
section 4946(a)(1)(E)). On January 1, 1980, X purchases for cash 40% of 
the only class of stock of Y corporation, a retail clothing store, from 
unrelated third parties.
    (ii) Under paragraph (a)(4) of this section, F is treated as owning 
nonvoting stock of Y. Although X is a disqualified person, its holdings 
are not treated as held by disqualified persons except as constructive 
holdings. Therefore, the ``deemed'' nonvoting stock in Y is a permitted 
holding because D, a disqualified person with respect to F, 
constructively owns only 16% of the voting stock of Y (less than 20% 
permitted under section 4943(c)(2)).
    Example 3. (i) The facts are the same as in Example (2), except that 
X purchases 100% of this stock of Y corporation. Under paragraph (a)(4) 
of this section, F is treated as owning nonvoting stock of Y. The 
``deemed'' nonvoting stock in Y is not a permitted holdings because D, a 
disqualified person with respect to F, constructively owns 40% of the 
voting stock of Y.
    Example 4. (i) D, a disqualified person with respect to F, owns 40% 
of the one class of stock in X corporation, an active business. X is a 
disqualified person with respect to F. X acquires 40% of the voting 
stock in Y corporation. Under paragraph (a)(5) of this section, the 
holdings of X in Y are treated as

[[Page 149]]

held by a disqualified person. F cannot hold any Y stock, voting or 
nonvoting.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6484, Feb. 22, 1984]



Sec. 53.4943-9  Business holdings; certain periods.

    (a) Taxable period--(1) In general. For purposes of section 4943, 
the term ``taxable period'' means, with respect to any excess business 
holdings of a private foundation in a business enterprise, the period 
beginning with the first day on which there are such excess business 
holdings and ending on the earliest of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on the holdings by the section 4943(a);
    (ii) The date on which the excess is eliminated; or
    (iii) The date on which the tax imposed by section 4943(a) is 
assessed.

For example, M, a private foundation, first has excess business holdings 
in X, a corporation, on February 5, 1972. A notice of deficiency is 
mailed under section 6212 to M on June 1, 1974. With respect to M 's 
excess business holdings in X, the taxable period begins on February 5, 
1972, and ends on June 1, 1974.
    (2) Special rule. Where a notice of deficiency referred to in 
subparagraph (1)(i) of this paragraph is not mailed because there is a 
waiver of the restrictions on assessment and collection of a deficiency, 
or because the deficiency is paid, the date of filing of the waiver or 
the date of such payment, respectively, shall be treated as the end of 
the taxable period.
    (3) Suspension of taxable period for 90 days. In any case in which a 
private foundation has excess business holdings solely because of the 
acquisition of an interest in a business enterprise to which paragraph 
(a)(1) (ii) or (iii) of Sec. 53.4943-2 applies, the taxable period 
described in paragraph (a) of this section shall be suspended for the 
90-day period (as extended) starting with the date on which the 
foundation knows or has reason to know of the acquisition, provided that 
at the end of such period the foundation has disposed of such excess 
holdings.
    (b) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4863(e), see 
section 4861(a) and the regulations thereunder.
    (c) Correction. For purposes of section 4943, correction shall be 
considered as made when no interest in the enterprise held by the 
foundation is classified as an excess business holdings under section 
4943(c)(1). In any case where the private foundation has excess business 
holdings which are constructively held for it under section 4943(c)(1), 
correction shall be considered made when either a corporation, 
partnership, estate, or trust in which holdings in such enterprise are 
constructively held for the foundation or a disqualified person; the 
foundation itself; or a disqualified person disposes of a sufficient 
interest in the enterprise so that no interest in the enterprise held by 
the foundation is classified as excess business holdings under section 
4943(c)(1).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4943-10  Business enterprise; definition.

    (a) In general. (1) Except as provided in paragraph (b) or (c) of 
this section under section 4943(d)(4) the term ``business enterprise'' 
includes the active conduct of a trade or business, including any 
activity which is regularly carried on for the production of income from 
the sale of goods or the performance of services and which constitutes 
an unrelated trade or business under section 513. For purposes of the 
preceding sentence, where an activity carried on for profit constitutes 
an unrelated trade or business, no part of such trade or business shall 
be excluded from the classification of a business enterprise merely 
because it does not result in a profit.
    (2) Notwithstanding paragraph (a)(1) of this section, a bond or 
other evidence of indebtedness does not constitute a holding in a 
business enterprise unless such bond or evidence of indebtedness is 
otherwise determined to be an equitable interest in such enterprise. 
Similarly, a lease-hold interest in real property does not constitute

[[Page 150]]

an interest in a business enterprise, even though rent payable under 
such lease is dependent, in whole or in part, upon the income or profits 
derived by another from such property, unless such leasehold interest 
constitutes an interest in the income or profits of an unrelated trade 
or business under section 513.
    (b) Certain program-related activities. For purposes of section 
4943(d)(4) the term ``business enterprise'' does not include a 
functionally related business as defined in section 4942(j)(5). See 
Sec. 53.4942(a)-2(c)(3)(iii). In addition, business holdings do not 
include program-related investments (such as investments in small 
businesses in central cities or in corporations to assist in 
neighborhood renovation) as defined in section 4944(c) and the 
regulations thereunder.
    (c) Income derived from passive sources--(1) In general. For 
purposes of section 4943(d)(4), the term ``business enterprise'' does 
not include a trade or business at least 95 percent of the gross income 
of which is derived from passive sources; except that if in the taxable 
year in question less than 95 percent of the income of a trade or 
business is from passive sources, the foundation may, in applying this 
95 percent test, substitute for the passive source gross income in such 
taxable year the average gross income from passive sources for the 10 
taxable years immediately preceding the taxable year in question (or for 
such shorter period as the entity has been in existence). Thus, stock in 
a passive holding company is not to be considered a holding in a 
business enterprise even if the company is controlled by the foundation. 
Instead, the foundation is treated as owning its proportionate share of 
any interests in a business enterprise held by such company under 
section 4943(d)(1).
    (2) Gross income from passive sources. Gross income from passive 
sources, for purposes of this paragraph, includes the items excluded by 
section 512(b)(1) (relating to dividends, interest, and annuities), 
512(b)(2) (relating to royalties), 512(b)(3) (relating to rent) and 
512(b)(5) (relating to gains or losses from the disposition of certain 
property). Any income classified as passive under this paragraph does 
not lose its character merely because section 512(b)(4) or 514 (relating 
to unrelated debt-financed income) applies to such income. In addition, 
income from passive sources includes income from the sale of goods 
(including charges or costs passed on at cost to purchasers of such 
goods or income received in settlement of a dispute concerning or in 
lieu of the exercise of the right to sell such goods) if the seller does 
not manufacture, produce, physically receive or deliver, negotiate sales 
of, or maintain inventories in such goods. Thus, for example, where a 
corporation purchases a product under a contract with the manufacturer, 
resells it under contract at a uniform markup in price, and does not 
physically handle the product, the income derived from that markup meets 
the definition of passive income for purposes of this paragraph. On the 
other hand, income from individually negotiated sales, such as those 
made by a broker, would not meet such definition even if the broker did 
not physically handle the goods.
    (3) Affiliated group. (i) For a common parent corporation in an 
affiliated group, substitute ``consolidated gross income'' in 
subparagraph (1) of this paragraph.
    (ii) For purposes of this section, the term affiliated group shall 
have the same meaning as in section 1504(a), without regard to section 
1504 (b) through (e).
    (iii) Section 53.4943-11(d) provides a transitional rule for certain 
parent corporations.
    (d) Application of section 4943(c)(6)--(1) Program related 
activities. If a private foundation holds an interest which is not an 
interest in a business enterprise because of paragraph (b) of this 
section (relating to program related activities), and such interest 
later becomes an interest in a business enterprise solely by reason of 
failing to meet the requirements of such paragraph (b), such interest 
will then be subject to section (regardless of when it was originally 
acquired) and will be treated as having been acquired other than by 
purchase for purposes of section 4943(c)(6).
    (2) Passive holdings, etc. (i) Except as provided in subdivision 
(ii), if a private

[[Page 151]]

foundation holds an interest that is not an interest in a business 
enterprise, and the interest later becomes an interest in a business 
enterprise (other than by reason of a readjustment as defined in Sec. 
53.4943-7(d)(1)), the interest will be treated as having been acquired 
by purchase by a disqualified person at the time the interest becomes an 
interest in a business enterprise. The treatment of an interest that 
becomes an interest in a business enterprise by reason of a readjustment 
shall be determined under Sec. 53.4943-6 and Sec. 53.4943-7.
    (ii) If a private foundation establishes that the events which 
caused an interest not originally a business enterprise to become a 
business enterprise were not effectively controlled by the private 
foundation, then such interest shall be treated as acquired other than 
by purchase from the time of the change for purposes of section 
4943(c)(6).
    (iii) See Sec. 53.4943-3(b)(3)(ii) for the definition of effective 
control.
    (e) Sole proprietorship. For purposes of section 4943 and the 
regulations thereunder, the term ``sole proprietorship'' means any 
business enterprise (as defined in paragraphs (a), (b), and (c) of this 
section:
    (1) Which is actually and directly owned by a private foundation,
    (2) In which the foundation has a 100 percent equity interest, and
    (3) Which is not held by a corporation, trust, or other business 
entity for such foundation.

A foundation may be considered to own a sole proprietorship even though 
the foundation is itself a corporation or a trust. However, a sole 
proprietorship which is owned by a foundation shall cease to be treated 
as a sole proprietorship when the foundation no longer has a 100-percent 
interest in the equity of the business enterprise. Thus, if and when a 
foundation sells a 10-percent interest in a sole proprietorship, such 
business enterprise shall be treated as a partnership under section 4943 
and the regulations thereunder.

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6484, Feb. 22, 1984]



Sec. 53.4943-11  Effective date.

    (a) In general. Section 4943 and Sec. Sec. 53.4943-1 through 
53.4943-11 shall take effect for taxable years beginning after December 
31, 1969, except as otherwise provided by such sections.
    (b) Special transitional rule. In the case of any acquisition of 
excess holdings prior to February 2, 1973, section 4943(a)(1) shall not 
apply if correction occurs (within the meaning of paragraph (c) of Sec. 
53.4943-9) within a period ending 90 days after July 5, 1977 extended 
(prior to the expiration of the original period) by any period which the 
Commissioner determines is reasonable and necessary (within the meaning 
of paragraph (b) of Sec. 53.4943-9) to bring about such correction.
    (c) Special transitional rule for acquisition by will, etc. (1) The 
rule in Sec. 53.4943-6(b)(1) whereby holdings not held by a decedent 
are not treated as acquired under a will shall not apply to acquisitions 
of after-acquired property of a decedent's estate occurring on or before 
May 22, 1984.
    (2) The rule in Sec. 53.4943-6(b)(1) treating a purchase by an 
estate as a purchase by a disqualified person where the executor is a 
disqualified person shall not apply to purchases occurring on or before 
May 22, 1984.
    (d) Special transitional rule for affiliated groups. If on or before 
May 22, 1984 a foundation holds an interest in a common parent 
corporation in an affiliated group, as defined in Sec. 53.4943-
10(c)(3)(ii), the foundation may elect to have both Sec. 53.4943-
8(c)(4) and Sec. 53.4943-10(c)(3) not apply to such common parent 
corporation. No election may be made to have only one section not apply. 
Such election shall be made by the governing body of the private 
foundation at any time prior to February 22, 1985.
    (e) Special transitional rule for changes to a business enterprise. 
Any interest that is not an interest in a business enterprise which 
becomes an interest in a business enterprise under Sec. 53.4943-
10(d)(2) prior to May 22, 1984 will be treated as having been acquired 
other than by purchase for purposes of section 4943(c)(6).

[T.D. 7496, 42 FR 46285, Sept. 15, 1977, as amended by T.D. 7944, 49 FR 
6485, Feb. 22, 1984]

[[Page 152]]



   Subpart E_Taxes on Investments Which Jeopardize Charitable Purpose

    Source: T.D. 7240, 37 FR 28747, Dec. 27, 1972, unless otherwise 
noted.



Sec. 53.4944-1  Initial taxes.

    (a) On the private foundation--(1) In general. If a private 
foundation (as defined in section 509) invests any amount in such a 
manner as to jeopardize the carrying out of any of its exempt purposes, 
section 4944(a) (1) of the Code imposes an excise tax on the making of 
such investment. This tax is to be paid by the private foundation and is 
at the rate of 5 percent of the amount so invested for each taxable year 
(or part thereof) in the taxable period (as defined in section 4944(e) 
(1)). The tax imposed by section 4944(a)(1) and this paragraph shall 
apply to investments of either income or principal.
    (2) Jeopardizing investments. (i) Except as provided in section 
4944(c), Sec. 53.4944-3, Sec. 53.4944-6(a), and subdivision (ii) of 
this subparagraph, an investment shall be considered to jeopardize the 
carrying out of the exempt purposes of a private foundation if it is 
determined that the foundation managers, in making such investment, have 
failed to exercise ordinary business care and prudence, under the facts 
and circumstances prevailing at the time of making the investment, in 
providing for the long- and short-term financial needs of the foundation 
to carry out its exempt purposes. In the exercise of the requisite 
standard of care and prudence the foundation managers may take into 
account the expected return (including both income and appreciation of 
capital), the risks of rising and falling price levels, and the need for 
diversification within the investment portfolio (for example, with 
respect to type of security, type of industry, maturity of company, 
degree of risk and potential for return). The determination whether the 
investment of a particular amount jeopardizes the carrying out of the 
exempt purposes of a foundation shall be made on an investment by 
investment basis, in each case taking into account the foundation's 
portfolio as a whole. No category of investments shall be treated as a 
per se violation of section 4944. However, the following are examples of 
types or methods of investment which will be closely scrutinized to 
determine whether the foundation managers have met the requisite 
standard of care and prudence: Trading in securities on margin, trading 
in commodity futures, investments in working interests in oil and gas 
wells, the purchase of ``puts,'' ``calls,'' and ``straddles,'' the 
purchase of warrants, and selling short. The determination whether the 
investment of any amount jeopardizes the carrying out of a foundation's 
exempt purposes is to be made as of the time that the foundation makes 
the investment and not subsequently on the basis of hindsight. 
Therefore, once it has been ascertained that an investment does not 
jeopardize the carrying out of a foundation's exempt purposes, the 
investment shall never be considered to jeopardize the carrying out of 
such purposes, even though, as a result of such investment, the 
foundation subsequently realizes a loss. The provisions of section 4944 
and the regulations thereunder shall not exempt or relieve any person 
from compliance with any Federal or State law imposing any obligation, 
duty, responsibility, or other standard of conduct with respect to the 
operation or administration of an organization or trust to which section 
4944 applies. Nor shall any State law exempt or relieve any person from 
any obligation, duty, responsibility, or other standard of conduct 
provided in section 4944 and the regulations thereunder.
    (ii)(a) Section 4944 shall not apply to an investment made by any 
person which is later gratuitously transferred to a private foundation. 
If such foundation furnishes any consideration to such person upon the 
transfer, the foundation will be treated as having made an investment 
(within the meaning of section 4944(a)(1)) in the amount of such 
consideration.
    (b) Section 4944 shall not apply to an investment which is acquired 
by a private foundation solely as a result of a corporate reorganization 
within the meaning of section 368(a).
    (iii) For purposes of section 4944, a private foundation which, 
after December 31, 1969, changes the form or terms

[[Page 153]]

of an investment (regardless of whether subdivision (ii) of this 
subparagraph applies to such investment), will be considered to have 
entered into a new investment on the date of such change, except as 
provided in subdivision (ii)(b) of this subparagraph. Accordingly, a 
determination, under subdivision (i) of this subparagraph, whether such 
change in the investment jeopardizes the carrying out of the 
foundation's exempt purposes shall be made at such time.
    (iv) It is not intended that the taxes imposed under Chapter 42 be 
exclusive. For example, if a foundation purchases a sole proprietorship 
in a business enterprise within the meaning of section 4943(d)(4), in 
addition to tax under section 4943, the foundation may be liable for tax 
under section 4944 if the investment jeopardizes the carrying out of any 
of its exempt purposes.
    (b) On the management--(1) In general. In any case in which a tax is 
imposed by section 4944(a)(1) and paragraph (a) of this section, section 
4944 (a)(2) of the Code imposes on the participation of any foundation 
manager in the making of the investment, knowing that it is jeopardizing 
the carrying out of any of the foundation's exempt purposes, a tax equal 
to 5 percent of the amount so invested for each taxable year of the 
foundation (or part thereof) in the taxable period (as defined in 
section 4944(e)(1)), subject to the provisions of section 4944(d) and 
Sec. 53.4944-4, unless such participation is not willful and is due to 
reasonable cause. The tax imposed under section 4944(a)(2) shall be paid 
by the foundation manager.
    (2) Definitions and special rules--(i) Knowing. For purposes of 
section 4944, a foundation manager shall be considered to have 
participated in the making of an investment ``knowing'' that it is 
jeopardizing the carrying out of any of the foundation's exempt purposes 
only if:
    (a) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such investment would be a jeopardizing 
investment under paragraph (a)(2) of this section,
    (b) He is aware that such an investment under these circumstances 
may violate the provisions of federal tax law governing jeopardizing 
investments, and
    (c) He negligently fails to make reasonable attempts to ascertain 
whether the investment is a jeopardizing investment, or he is in fact 
aware that it is such an investment.

For purposes of this part and Chapter 42, the term knowing does not mean 
``having reason to know''. However, evidence tending to show that a 
foundation manager has reason to know of a particular fact or particular 
rule is relevant in determining whether he had actual knowledge of such 
fact or rule. Thus, for example, evidence tending to show that a 
foundation manager has reason to know of sufficient facts so that, based 
solely upon such facts, an investment would be a jeopardizing investment 
is relevant in determining whether he has actual knowledge of such 
facts.
    (ii) Willful. A foundation manager's participation in a jeopardizing 
investment is willful if it is voluntary, conscious, and intentional. No 
motive to avoid the restrictions of the law or the incurrence of any tax 
is necessary to make such participation willfull. However, a foundation 
manager's participation in a jeopardizing investment is not willful if 
he does not know that it is a jeopardizing investment under paragraph 
(a)(2) of this section.
    (iii) Due to reasonable cause. A foundation manager's actions are 
due to reasonable cause if he has exercised his responsibility on behalf 
of the foundation with ordinary business care and prudence.
    (iv) Participation. The participation of any foundation manager in 
the making of an investment shall consist of any manifestation of 
approval of the investment.
    (v) Advice of counsel. If a foundation manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of such counsel expressed in a reasoned 
written legal opinion that a particular investment would not jeopardize 
the carrying out of any of the foundation's exempt purposes (because, as 
a matter of law, the investment is excepted from such classification, 
for

[[Page 154]]

example, as a program-related investment under section 4944(c)), then 
although such investment is subsequently held to be a jeopardizing 
investment under paragraph (a)(2) of this section, the foundation 
manager's participation in such investment will ordinarily not be 
considered ``knowing'' or ``willfull'' and will ordinarily be considered 
``due to reasonable cause'' within the meaning of section 4944(a) (2). 
In addition, if a foundation manager, after full disclosure of the 
factual situation to qualified investment counsel, relies on the advice 
of such counsel, such advice being derived in a manner consistent with 
generally accepted practices of persons who are such a qualified 
investment counsel and being expressed in writing that a particular 
investment will provide for the long and short term financial needs of 
the foundation under paragraph (a)(2) of this section, then although 
such investment is subsequently held not to provide for such long and 
short term financial needs, the foundation manager's participation in 
failing to provide for such long and short term financial needs will 
ordinarily not be considered ``knowing'' or ``willful'' and will 
ordinarily be considered ``due to reasonable cause'' within the meaning 
of section 4944(a)(2). For purposes of this subdivision, a written legal 
opinion will be considered ``reasoned'' even if it reaches a conclusion 
which is subsequently determined to be incorrect so long as such opinion 
addresses itself to the facts and applicable law. However, a written 
legal opinion will not be considered ``reasoned'' if it does nothing 
more than recite the facts and express a conclusion. However, the 
absence of advice of legal counsel or qualified investment counsel with 
respect to the investment shall not, by itself, give rise to any 
inference that a foundation manager participated in such investment 
knowingly, willfully, or without reasonable cause.
    (vi) Cross reference. For provisions relating to the burden of proof 
in cases involving the issue whether a foundation manager has knowingly 
participated in the making of a jeopardizing investment, see section 
7454(b).
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A is a foundation manager of B, a private foundation with 
assets of $100,000. A approves the following three investments by B 
after taking into account with respect to each of them B's portfolio as 
a whole: (1) An investment of $5,000 in the common stock of corporation 
X; (2) an investment of $10,000 in the common stock of corporation Y; 
and (3) an investment of $8,000 in the common stock of corporation Z. 
Corporation X has been in business a considerable time, its record of 
earnings is good and there is no reason to anticipate a diminution of 
its earnings. Corporation Y has a promising product, has had earnings in 
some years and substantial losses in others, has never paid a dividend, 
and is widely reported in investment advisory services as seriously 
undercapitalized. Corporation Z has been in business a short period of 
time and manufactures a product that is new, is not sold by others, and 
must compete with a well-established alternative product that serves the 
same purpose. Z's stock is classified as a high-risk investment by most 
investment advisory services with the possibility of substantial long-
term appreciation but with little prospect of a current return. A has 
studied the records of the three corporations and knows the foregoing 
facts. In each case the price per share of common stock purchased by B 
is favorable to B. Under the standards of paragraph (a)(2)(i) of this 
section, the investment of $10,000 in the common stock of Y and the 
investment of $8,000 in the common stock of Z may be classified as 
jeopardizing investments, while the investment of $5,000 in the common 
stock of X will not be so classified. B would then be liable for an 
initial tax of $500 (i.e., 5 percent of $10,000) for each year (or part 
thereof) in the taxable period for the investment in Y, and an initial 
tax of $400 (i.e., 5 percent of $8,000) for each year (or part thereof) 
in the taxable period for the investment in Z. Further, since A had 
actual knowledge that the investments in the common stock of Y and Z 
were jeopardizing investments, A would then be liable for the same 
amount of initial taxes as B.
    Example 2. Assume the facts as stated in Example (1), except that: 
(1) In the case of corporation Y, B's investment will be made for new 
stock to be issued by Y and there is reason to anticipate that B's 
investment, together with investments required by B to be made 
concurrently with its own, will satisfy the capital needs of corporation 
Y and will thereby overcome the difficulties that have resulted in Y's 
uneven earnings record; and (2) in the case of corporation Z, the 
management has a demonstrated capacity for getting new businesses 
started successfully and Z has received substantial orders for its new

[[Page 155]]

product. Under the standards of paragraph (a) (2) (i) of this section, 
neither the investment in Y nor the investment in Z will be classified 
as a jeopardizing investment and neither A nor B will be liable for an 
initial tax on either of such investments.
    Example 3. D is a foundation manager of E, a private foundation with 
assets of $200,000. D was hired by E to manage E's investments after a 
careful review of D's training, experience and record in the field of 
investment management and advice indicated to E that D was well 
qualified to provide professional investment advice in the management of 
E's investment assets. D, after careful research into how best to 
diversify E's investments, provide for E's long-term financial needs, 
and protect against the effects of long-term inflation, decides to 
allocate a portion of E's investment assets to unimproved real estate in 
selected areas of the country where population patterns and economic 
factors strongly indicate continuing growth at a rapid rate. D 
determines that the short-term financial needs of E can be met through 
E's other investments. Under the standards of paragraph (a)(2)(i) of 
this section, the investment of a portion of E's investment assets in 
unimproved real estate will not be classified as a jeopardizing 
investment and neither D nor E will be liable for an initial tax on such 
investment.

[T.D. 7240, 37 FR 28747, Dec. 29, 1972, as amended by T.D. 7299, 38 FR 
35304, Dec. 27, 1973]



Sec. 53.4944-2  Additional taxes.

    (a) On the private foundation. Section 4944(b)(1) of the Code 
imposes an excise tax in any case in which an initial tax is imposed by 
section 4944(a)(1) and Sec. 53.4944-1(a) on the making of a 
jeopardizing investment by a private foundation and such investment is 
not removed from jeopardy within the taxable period (as defined in 
section 4944(e)(1)). The tax imposed under section 4944(b)(1) is to be 
paid by the private foundation and is at the rate of 25 percent of the 
amount of the investment. This tax shall be imposed upon the portion of 
the investment which has not been removed from jeopardy within the 
taxable period.
    (b) On the management. Section 4944(b)(2) of the Code imposes an 
excise tax in any case in which an additional tax is imposed by section 
4944 (b)(1) and paragraph (a) of this section and a foundation manager 
has refused to agree to part or all of the removal of the investment 
from jeopardy. The tax imposed under section 4944(b)(2) is at the rate 
of 5 percent of the amount of the investment, subject to the provisions 
of section 4944(d) and Sec. 53.4944-4. This tax is to be paid by any 
foundation manager who has refused to agree to the removal of part or 
all of the investment from jeopardy, and shall be imposed upon the 
portion of the investment which has not been removed from jeopardy 
within the taxable period.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X is a foundation manager of Y, a private foundation. On 
the advice of X, Y invests $5,000 in the common stock of corporation M. 
Assume that both X and Y are liable for the taxes imposed by section 
4944(a) on the making of the investment. Assume further that no part of 
the investment is removed from jeopardy within the taxable period and 
that X refused to agree to such removal. Y will be liable for an 
additional tax of $1,250 (i.e., $5,000x25%). X will be liable for an 
additional tax of $250 (i.e., $5,000x5%).
    Example 2. Assume the facts as stated in Example (1), except that X 
is not liable for the tax imposed by section 4944(a)(2) for his 
participation in the making of the investment, because such 
participation was not willful and was due to reasonable cause. X will 
nonetheless be liable for the tax of $250 imposed by section 4944(b)(2) 
since an additional tax has been imposed upon Y and since X refused to 
agree to the removal of the investment from jeopardy.
    Example 3. Assume the facts as stated in Example (1), except that Y 
removes $2,000 of the investment from jeopardy within the taxable 
period, with X refusing to agree to the removal from jeopardy of the 
remaining $3,000 of such investment. Y will be liable for an additional 
tax of $750, imposed upon the portion of the investment which has not 
been removed from jeopardy within the taxable period (i.e., $3,000x25%). 
Further X will be liable for an additional tax of $150, also imposed 
upon the same portion of the investment (i.e., $3,000x5%).

[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR 
16302, May 2, 1986]



Sec. 53.4944-3  Exception for program-related investments.

    (a) In general. (1) For purposes of section 4944 and Sec. Sec. 
53.4944-1 through 53.4944-6, a ``program-related investment'' shall not 
be classified as an investment which jeopardizes the carrying out of the 
exempt purposes of a private foundation. A program-related

[[Page 156]]

investment is an investment which possesses the following 
characteristics:
    (i) The primary purpose of the investment is to accomplish one or 
more of the purposes described in section 170(c)(2)(B);
    (ii) No significant purpose of the investment is the production of 
income or the appreciation of property; and
    (iii) No purpose of the investment is to accomplish one or more of 
the purposes described in section 170(c)(2)(D).
    (2)(i) 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. For purposes of 
section 4944 and Sec. Sec. 53.4944-1 through 53.4944-6, the term 
purposes described in section 170(c)(2)(B) shall be treated as including 
purposes described in section 170(c)(2)(B) whether or not carried out by 
organizations described in section 170(c).
    (ii) An investment in an activity described in section 4942(j)(5)(B) 
and the regulations thereunder shall be considered, for purposes of this 
paragraph, as made primarily to accomplish one or more of the purposes 
described in section 170(c)(2)(B).
    (iii) 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. However, the fact that an investment produces significant 
income or capital appreciation shall not, in the absence of other 
factors, be conclusive evidence of a significant purpose involving the 
production of income or the appreciation of property.
    (iv) An investment shall not be considered as made to accomplish one 
or more of the purposes described in section 170(c)(2)(D) if the 
recipient of the investment appears before, or communicates to, any 
legislative body with respect to legislation or proposed legislation of 
direct interest to such recipient, provided that the expense of engaging 
in such activities would qualify as a deduction under section 162.
    (3)(i) Once it has been determined that an investment is ``program-
related'' it shall not cease to qualify as a ``program-related 
investment'' provided that changes, if any, in the form or terms of the 
investment are made primarily for exempt purposes and not for any 
significant purpose involving the production of income or the 
appreciation of property. A change made in the form or terms of a 
program-related investment for the prudent protection of the 
foundation's investment shall not ordinarily cause the investment to 
cease to qualify as program-related. Under certain conditions, a 
program-related investment may cease to be program-related because of a 
critical change in circumstances, as, for example, where it is serving 
an illegal purpose or the private purpose of the foundation or its 
managers. For purposes of the preceding sentence, an investment which 
ceases to be program-related because of a critical change in 
circumstances shall in no event subject the foundation making the 
investment to the tax imposed by section 4944(a)(1) before the 30th day 
after the date on which such foundation (or any of its managers) has 
actual knowledge of such critical change in circumstances.
    (ii) If a private foundation changes the form or terms of an 
investment, and if, as a result of the application of subdivision (i) of 
this subparagraph, such investment no longer qualifies as program-
related, the determination whether the investment jeopardizes the 
carrying out of exempt purposes shall be made pursuant to the provisions 
of Sec. 53.4944-1(a)(2).
    (b) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X is a small business enterprise located in a 
deteriorated urban area and owned by members of an economically 
disadvantaged minority group. Conventional sources of funds are 
unwilling or unable to provide funds to X on terms it considers 
economically feasible. Y, a private foundation, makes a loan to X 
bearing interest below the market rate for commercial loans of 
comparable risk. Y's primary purpose for making

[[Page 157]]

the loan is to encourage the economic development of such minority 
groups. The loan has no significant purpose involving the production of 
income or the appreciation of property. The loan significantly furthers 
the accomplishment of Y's exempt activities and would not have been made 
but for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment even though Y may 
earn income from the investment in an amount comparable to or higher 
than earnings from conventional portfolio investments.
    Example 2. Assume the facts as stated in Example (1), except that 
after the date of execution of the loan Y extends the due date of the 
loan. The extension is granted in order to permit X to achieve greater 
financial stability before it is required to repay the loan. Since the 
change in the terms of the loan is made primarily for exempt purposes 
and not for any significant purpose involving the production of income 
or the appreciation of property, the loan shall continue to qualify as a 
program-related investment.
    Example 3. X is a small business enterprise located in a 
deteriorated urban area and owned by members of an economically 
disadvantaged minority group. Conventional sources of funds are 
unwilling to provide funds to X at reasonable interest rates unless it 
increases the amount of its equity capital. Consequently, Y, a private 
foundation, purchases shares of X's common stock. Y's primary purpose in 
purchasing the stock is to encourage the economic development of such 
minority group, and no significant purpose involves the production of 
income or the appreciation of property. The investment significantly 
furthers the accomplishment of Y's exempt activities and would not have 
been made but for such relationship between the investment and Y's 
exempt activities. 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.
    Example 4. X is a business enterprise which is not owned by low-
income persons or minority group members, but the continued operation of 
X is important to the economic well-being of a deteriorated urban area 
because X employes a substantial number of low-income persons from such 
area. Conventional sources of funds are unwilling or unable to provide 
funds to X at reasonable interest rates. Y, a private foundation, makes 
a loan to X at an interest rate below the market rate for commercial 
loans of comparable risk. The loan is made pursuant to a program run by 
Y to assist low-income persons by providing increased economic 
opportunities and to prevent community deterioration. No significant 
purpose of the loan involves the production of income or the 
appreciation of property. The investment significantly furthers the 
accomplishment of Y's exempt activities and would not have been made but 
for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment.
    Example 5. X is a business enterprise which is financially secure 
and the stock of which is listed and traded on a national exchange. Y, a 
private foundation, makes a loan to X at an interest rate below the 
market rate in order to induce X to establish a new plant in a 
deteriorated urban area which, because of the high risks involved, X 
would be unwilling to establish absent such inducement. The loan is made 
pursuant to a program run by Y to enhance the economic development of 
the area by, for example, providing employment opportunities for low-
income persons at the new plant, and no significant purpose involves the 
production of income or the appreciation of property. The loan 
significantly furthers the accomplishment of Y's exempt activities and 
would not have been made but for such relationship between the loan and 
Y's exempt activities. Accordingly, even though X is large and 
established, the investment is program-related.
    Example 6. X is a business enterprise which is owned by a nonprofit 
community development corporation. When fully operational, X will market 
agricultural products, thereby providing a marketing outlet for low-
income farmers in a depressed rural area. Y, a private foundation, makes 
a loan to X bearing interest at a rate less than the rate charged by 
financial institutions which have agreed to lend funds to X if Y makes 
the loan. The loan is made pursuant to a program run by Y to encourage 
economic redevelopment of depressed areas, and no significant purpose 
involves the production of income or the appreciation of property. The 
loan significantly furthers the accomplishment of Y's exempt activities 
and would not have been made but for such relationship between the loan 
and Y's exempt activities. Accordingly, the loan is a program-related 
investment.
    Example 7. X, a private foundation, invests $100,000 in the common 
stock of corporation M. The dividends received from such investment are 
later applied by X in furtherance of its exempt purposes. Although there 
is a relationship between the return on the investment and the 
accomplishment of X's exempt activities, there is no relationship 
between the investment per se and such accomplishment. Therefore, the 
investment cannot be considered as made primarily to accomplish one or 
more of the purposes described in section 170(c)(2)(B) and cannot 
qualify as program-related.
    Example 8. S, a private foundation, makes an investment in T, a 
business corporation, which qualifies as a program-related investment 
under section 4944(c) at the time that it is made. All of T's voting 
stock is owned

[[Page 158]]

by S. T experiences financial and management problems which, in the 
judgment of the foundation, require changes in management, in financial 
structure or in the form of the investment. The following three methods 
of resolving the problems appear feasible to S, but each of the three 
methods would result in reduction of the exempt purposes for which the 
program-related investment was initially made:
    (a) Sale of stock or assets. The foundation sells its stock to an 
unrelated person. Payment is made in part at the time of sale; the 
balance is payable over an extended term of years with interest on the 
amount outstanding. The foundation receives a purchase-money mortgage.
    (b) Lease. The corporation leases its assets for a term of years to 
an unrelated person, with an option in the lessee to buy the assets. If 
the option is exercised, the terms of payment are to be similar to those 
described in (a) of this example.
    (c) Management contract. The corporation enters into a management 
contract which gives broad operating authority to one or more unrelated 
persons for a term of years. The foundation and the unrelated persons 
are obligated to contribute toward working capital requirements. The 
unrelated persons will be compensated by a fixed fee or a share of 
profits, and they will receive an option to buy the stock held by S or 
the assets of the corporation. If the option is exercised, the terms of 
payment are to be similar to those described in (a) of this example.


Each of the three methods involves a change in the form or terms of a 
program-related investment for the prudent protection of the 
foundation's investment. Thus, under Sec. 53.4944-3(a)(3)(i), none of 
the three transactions (nor any debt instruments or other obligations 
held by S as a result of engaging in one of these transactions) would 
cause the investment to cease to qualify as program-related.
    Example 9. X is a socially and economically disadvantaged 
individual. Y, a private foundation, makes an interest-free loan to X 
for the primary purpose of enabling X to attend college. The loan has no 
significant purpose involving the production of income or the 
appreciation of property. The loan significantly furthers the 
accomplishment of Y's exempt activities and would not have been made but 
for such relationship between the loan and Y's exempt activities. 
Accordingly, the loan is a program-related investment.
    Example 10. Y, a private foundation, makes a high-risk investment in 
low-income housing, the indebtedness with respect to which is insured by 
the Federal Housing Administration. Y's primary purpose in making the 
investment is to finance the purchase, rehabilitation, and construction 
of housing for low-income persons. The investment has no significant 
purpose involving the production of income or the appreciation of 
property. The investment significantly furthers the accomplishment of 
Y's exempt activities and would not have been made but for such 
relationship between the investment and Y's exempt activities. 
Accordingly, the investment is program-related.



Sec. 53.4944-4  Special rules.

    (a) Joint and several liability. In any case where more than one 
foundation manager is liable for the tax imposed under section 4944 
(a)(2) or (b)(2) with respect to any one jeopardizing investment, all 
such foundation managers shall be jointly and severally liable for the 
tax imposed under each such paragraph with respect to such investment.
    (b) Limits on liability for management. With respect to anyone 
jeopardizing investment, the maximum aggregate amount of tax collectible 
under section 4944(a)(2) from all foundation managers shall not exceed 
$5,000, and the maximum aggregate amount of tax collectible under 
section 4944(b)(2) from all foundation managers shall not exceed 
$10,000.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A, B, and C are foundation managers of X, a private 
foundation. Assume that A, B, and C are liable for both initial and 
additional taxes under sections 4944(a)(2) and 4944(b)(2), respectively, 
for the following investments by X: an investment of $5,000 in the 
common stock of corporation M, and an investment of $10,000 in the 
common stock of corporation N. A, B, and C will be jointly and severally 
liable for the following initial taxes under section 4944(a)(2): a tax 
of $250 (i.e., 5 percent of $5,000) for each year (or part thereof) in 
the taxable period (as defined in section 4944(e)(1)) for the investment 
in M, and a tax of $500 (i.e., 5 percent of $10,000) for each year (or 
part thereof) in the taxable period for the investment in N. Further, A, 
B, and C will be jointly and severally liable for the following 
additional taxes under section 4944(b)(2): a tax of $250 (i.e., 5 
percent of $5,000) for the investment in M, and a tax of $500 (i.e., 5 
percent of $10,000) for the investment in N.
    Example 2. Assume the facts as stated in Example (1), except that X 
has invested $500,000 in the common stock of M, and $1 million in the 
common stock of N. A, B, and C will be jointly and severally liable for 
the following initial taxes under section 4944(a)(2): a tax of $5,000 
for the investment in M, and a tax of $5,000 for the investment

[[Page 159]]

in N. Further, A, B, and C will be jointly and severally liable for the 
following additional taxes under section 4944(b) (2): a tax of $10,000 
for the investment in M, and a tax of $10,000 for the investment in N.



Sec. 53.4944-5  Definitions.

    (a) Taxable period--(1) In general. For purposes of section 4944, 
the term ``taxable period'' means, with respect to any investment which 
jeopardizes the carrying out of a private foundation's exempt purposes, 
the period beginning with the date on which the amount is invested and 
ending on the earliest of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on the making of the investment by 
section 4944(a)(1);
    (ii) The date on which the amount invested is removed from jeopardy; 
or
    (iii) The date on which the tax imposed by section 4944(a)(1) is 
assessed.
    (2) Special rule. Where a notice of deficiency referred to in 
subparagraph (1) (i) of this paragraph is not mailed because there is a 
waiver of the restrictions on assessment and collection of a deficiency, 
or because the deficiency is paid, the date of filing of the waiver or 
the date of such payment, respectively, shall be treated as the end of 
the taxable period.
    (b) Removal from jeopardy. An investment which jeopardizes the 
carrying out of a private foundation's exempt purposes shall be 
considered to be removed from jeopardy when:
    (1) The foundation sells or otherwise disposes of the investment, 
and
    (2) The proceeds of such sale or other disposition are not 
themselves investments which jeopardize the carrying out of such 
foundation's exempt purposes.

A change by a private foundation in the form or terms of a jeopardizing 
investment shall result in the removal of the investment from jeopardy 
if, after such change, the investment no longer jeopardizes the carrying 
out of such foundation's exempt purposes. For purposes of section 4944, 
the making by a private foundation of one jeopardizing investment and a 
subsequent exchange by the foundation of such investment for another 
jeopardizing investment will be treated as only one jeopardizing 
investment, except as provided in Sec. 53.4944-6 (b) and (c). For the 
treatment of a jeopardizing investment which is removed from jeopardy or 
otherwise transferred by a private foundation by the making of a grant 
or by bargain-sale, see sections 4941 and 4945 and the regulations 
thereunder. A jeopardizing investment cannot be removed from jeopardy by 
a transfer from a private foundation to another private foundation which 
is related to the transferor foundation within the meaning of section 
4946(a) (1)(H) (i) or (ii), unless the investment is a program-related 
investment in the hands of the transferee foundation.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, a private foundation on the calendar year basis, makes 
a $1,000 jeopardizing investment on January 1, 1970. X thereafter sells 
the investment for $1,000 on January 3, 1971. The taxable period is from 
January 1, 1970, to January 3, 1971. X will be liable for an initial tax 
of $100, that is, a tax of 5 percent of the amount of the investment for 
each year (or part thereof) in the taxable period.
    Example 2. Assume that both C and D are investments which jeopardize 
exempt purposes. X, a private foundation, purchases C in 1971 and later 
exchanges C for D. Such exchange does not constitute a removal of C from 
jeopardy. In addition, no new taxable period will arise with respect to 
D, since, for purposes of section 4944, only one jeopardizing investment 
has been made.
    Example 3. Assume the facts as stated in Example (2), except that X 
sells C for cash and later reinvests such cash in D. Two separate 
investments jeopardizing exempt purposes have resulted. Since the cash 
received in the interim is not of a jeopardizing nature, the amount 
invested in C has been removed from jeopardy and, thus, the taxable 
period with respect to C has been terminated. The subsequent 
reinvestment of such cash in D gives rise to a new taxable period with 
respect to D.

    (d) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961(a) and the regulations thereunder.

[T.D. 7240, 37 FR 28747, Dec. 27, 1972, as amended by T.D. 8084, 51 FR 
16303, May 2, 1986]

[[Page 160]]



Sec. 53.4944-6  Special rules for investments made prior to January 1, 1970.

    (a) Except as provided in paragraph (b) or (c) of this section, an 
investment made by a private foundation prior to January 1, 1970, shall 
not be subject to the provisions of section 4944.
    (b) If the form or terms of an investment made by a private 
foundation prior to January 1, 1970, are changed (other than as 
described in paragraph (c) of this section) on or after such date, the 
provisions of Sec. 53.4944-1(a)(2)(iii) shall apply with respect to 
such investment.
    (c) In the case of an investment made by a private foundation prior 
to January 1, 1970, which is exchanged on or after such date for another 
investment, for purposes of section 4944 the foundation will be 
considered to have made a new investment on the date of such exchange, 
unless the post-1969 investment is described in Sec. 53.4944-
1(a)(2)(ii)(b). Accordingly, a determination, under Sec. 53.4944-1(a) 
(2)(i), whether the investment jeopardizes the carrying out of the 
foundation's exempt purposes shall be made at such time.



                 Subpart F_Taxes on Taxable Expenditures

    Source: T.D. 7215, 37 FR 23161, Oct. 31, 1972, unless otherwise 
noted.



Sec. 53.4945-1  Taxes on taxable expenditures.

    (a) Imposition of initial taxes--(1) Tax on private foundation. 
Section 4945(a)(1) of the Code imposes an excise tax on each taxable 
expenditure (as defined in section 4945(d)) of a private foundation. 
This tax is to be paid by the private foundation and is at the rate of 
10 percent of the amount of each taxable expenditure.
    (2) Tax on foundation manager--(i) In general. Section 4945(a)(2) of 
the Code imposes, under certain circumstances, an excise tax on the 
agreement of any foundation manager to the making of a taxable 
expenditure by a private foundation. This tax is imposed only in cases 
in which the following circumstances are present:
    (a) A tax is imposed by section 4945(a)(1);
    (b) Such foundation manager knows that the expenditure to which he 
agrees is a taxable expenditure, and
    (c) Such agreement is willfull and is not due to reasonable cause.


However, the tax with respect to any particular expenditure applies only 
to the agreement of those foundation managers who are authorized to 
approve, or to exercise discretion in recommending approval of, the 
making of the expenditure by the foundation and to those foundation 
managers who are members of a group (such as the foundation's board of 
directors or trustees) which is so authorized. For the definition of the 
term foundation manager, see section 4946(b) and the regulations 
thereunder.
    (ii) Agreement. The agreement of any foundation manager to the 
making of a taxable expenditure shall consist of any manifestation of 
approval of the expenditure which is sufficient to constitute an 
exercise of the foundation manager's authority to approve, or to 
exercise discretion in recommending approval of, the making of the 
expenditure by the foundation, whether or not such manifestation of 
approval is the final or decisive approval on behalf of the foundation.
    (iii) Knowing. For purposes of section 4945, a foundation mangager 
shall be considered to have agreed to an expenditure ``knowing'' that it 
is a taxable expenditure only if:
    (a) He has actual knowledge of sufficient facts so that, based 
solely upon such facts, such expenditure would be a taxable expenditure,
    (b) He is aware that such an expenditure under these circumstances 
may violate the provisions of federal tax law governing taxable 
expenditures, and
    (c) He negligently fails to make reasonable attempts to ascertain 
whether the expenditure is a taxable expenditure, or he is in fact aware 
that it is such an expenditure.


For purposes of this part and Chapter 42, the term knowing does not mean 
``having reason to know''. However, evidence tending to show that a 
foundation manager has reason to know of a particular fact or particular 
rule is relevant in determining whether he

[[Page 161]]

had actual knowledge of such fact or rule. Thus, for example, evidence 
tending to show that a foundation manager has reason to know of 
sufficient facts so that, based solely upon such facts, an expenditure 
would be a taxable expenditure is relevant in determining whether he has 
actual knowledge of such facts.
    (iv) Willful. A foundation manager's agreement to a taxable 
expenditure is willful if it is voluntary, conscious, and intentional. 
No motive to avoid the restrictions of the law or the incurrence of any 
tax is necessary to make an agreement willful. However, a foundation 
manager's agreement to a taxable expenditure is not willful if he does 
not know that it is a taxable expenditure.
    (v) Due to reasonable cause. A foundation manager's actions are due 
to reasonable cause if he has exercised his responsibility on behalf of 
the foundation with ordinary business care and prudence.
    (vi) Advice of counsel. If a foundation manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of such counsel expressed in a reasoned 
written legal opinion that an expenditure is not a taxable expenditure 
under section 4945 (or that expenditures conforming to certain 
guidelines are not taxable expenditures), although such expenditure is 
subsequently held to be a taxable expenditure (or that certain proposed 
reporting procedures with respect to an expenditure will satisfy the 
tests of section 4945(h), although such procedures are subsequently held 
not to satisfy such section), the foundation manager's agreement to such 
expenditure (or to grants made with provision for such reporting 
procedures which are taxable solely because of such inadequate reporting 
procedures) will ordinarily not be considered ``knowing'' or ``willful'' 
and will ordinarily be considered ``due to reasonable cause'' within the 
meaning of section 4945(a)(2). For purposes of the subdivision, a 
written legal opinion will be considered ``reasoned'' even if it reaches 
a conclusion which is subsequently determined to be incorrect so long as 
such opinion addresses itself to the facts and applicable law. However, 
a written legal opinion will not be considered ``reasoned'' if it does 
nothing more than recite the facts and express a conclusion. However, 
the absence of advice of counsel with respect to an expenditure shall 
not, by itself, give rise to any inference that a foundation manager 
agreed to the making of the expenditure knowingly, willfully, or without 
reasonable cause.
    (vii) Rate and incidence of tax. The tax imposed under section 
4945(a)(2) is at the rate of 2\1/2\ percent of the amount of each 
taxable expenditure to which the foundation manager has agreed. This tax 
shall be paid by the foundation manager.
    (viii) Cross reference. For provisions relating to the burden of 
proof in cases involving the issue whether a foundation manager has 
knowingly agreed to the making of a taxable expenditure, see section 
7454(b).
    (b) Imposition of additional taxes--(1) Tax on private foundation. 
Section 4945(b)(1) of the Code imposes an excise tax in any case in 
which an initial tax is imposed under section 4945(a)(1) on a taxable 
expenditure of a private foundation and the expenditure is not corrected 
within the taxable period (as defined in section 4945(i)(2)). The tax 
imposed under section 4945(b)(1) is to be paid by the private foundation 
and is at the rate of 100 percent of the amount of each taxable 
expenditure.
    (2) Tax on foundation manager. Section 4945(b)(2) of the Code 
imposes an excise tax in any case in which a tax is imposed under 
section 4945(b)(1) and a foundation manager has refused to agree to part 
or all of the correction of the taxable expenditure. The tax imposed 
under section 4945(b)(2) is at the rate of 50 percent of the amount of 
the taxable expenditure. This tax is to be paid by any foundation 
manager who has refused to agree to part or all of the correction of the 
taxable expenditure.
    (c) Special rules--(1) Joint and several liability. In any case 
where more than one foundation manager is liable for tax imposed under 
section 4945 (a) (2) or (b)(2) with respect to the making of a taxable 
expenditure, all such foundation managers shall be jointly and severally 
liable for the tax imposed under such paragraph with respect to such 
taxable expenditure.

[[Page 162]]

    (2) Limits on liability for management. The maximum aggregate amount 
of tax collectible under section 4945(a)(2) from all foundation managers 
with respect to any one taxable expenditure shall be $5,000, and the 
maximum aggregate amount of tax collectible under section 4945(b) (2) 
from all foundation managers with respect to any one taxable expenditure 
shall be $10,000.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, B, and C comprise the board of directors of Foundation 
M. They vote unanimously in favor of a grant of $100,000 to D, a 
business associate of each of the directors. The grant is to be used by 
D for travel and educational purposes and is not made in accordance with 
the requirements of section 4945(g). Each director knows that D was 
selected as the recipient of the grant solely because of his friendship 
with the directors and is aware that some grants made for travel, study, 
or other similar purposes may be taxable expenditures. Also, none of the 
directors makes any attempt to consult counsel, or to otherwise 
determine, whether this grant is a taxable expenditure. Initial taxes 
are imposed under paragraphs (1) and (2) of section 4945(a). The tax to 
be paid by the foundation is $10,000 (10 percent of $100,000). The tax 
to be paid by the board of directors is $2,500 (2\1/2\ percent of 
$100,000). A, B, and C are jointly and severally liable for this $2,500 
and this sum may be collected by the Service from any one of them.
    Example 2. Assume the same facts as in example (1). Further assume 
that within the taxable period A makes a motion to correct the taxable 
expenditure at a meeting of the board of directors. The motion is 
defeated by a two-to-one vote, A voting for the motion and B and C 
voting against it. In these circumstances an additional tax is imposed 
on the private foundation in the amount of $100,000 (100 percent of 
$100,000). The additional tax imposed on B and C is $10,000 (50 percent 
of $100,000 subject to a maximum of $10,000). B and C are jointly and 
severally liable for the $10,000, and this sum may be collected by the 
Service from either of them.

    (d) Correction--(1) In general. Except as provided in paragraph (d) 
(2) or (3) of this paragraph, correction of a taxable expenditure shall 
be accomplished by recovering part or all of the expenditure to the 
extent recovery is possible, and, where full recovery cannot be 
accomplished, by any additional corrective action which the Commissioner 
may prescribe. Such additional corrective action is to be determined by 
the circumstances of each particular case and may include the following:
    (i) Requiring that any unpaid funds due the grantee be withheld;
    (ii) Requiring that no further grants be made to the particular 
grantee;
    (iii) In addition to other reports that are required, requiring 
periodic (e.g., quarterly) reports from the foundation with respect to 
all expenditures of the foundation (such reports shall be equivalent in 
detail to the reports required by section 4945(h)(3) and Sec. 53.4945-
5(d));
    (iv) Requiring improved methods of exercising expenditure 
responsibility;
    (v) Requiring improved methods of selecting recipients of individual 
grants; and
    (vi) Requiring such other measures as the Commissioner may prescribe 
in a particular case.

The foundation making the expenditure shall not be under any obligation 
to attempt to recover the expenditure by legal action if such action 
would in all probability not result in the satisfaction of execution on 
a judgment.
    (2) Correction for inadequate reporting. If the expenditure is 
taxable only because of a failure to obtain a full and complete report 
as required by section 4945(h)(2) or because of a failure to make a full 
and detailed report as required by section 4945(h)(3), correction may be 
accomplished by obtaining or making the report in question. In addition, 
if the expenditure is taxable only because of a failure to obtain a full 
and complete report as required by section 4945(h)(2) and an 
investigation indicates that no grant funds have been diverted to any 
use not in furtherance of a purpose specified in the grant, correction 
may be accomplished by exerting all reasonable efforts to obtain the 
report in question and reporting the failure to the Internal Revenue 
Service, even though the report is not finally obtained.
    (3) Correction for failure to obtain advance approval. Where an 
expenditure is taxable under section 4945(d)(3) only because of a 
failure to obtain advance approval of procedures with respect to grants 
as required by section 4945(g), correction may be accomplished by 
obtaining approval of the grant making procedures and establishing to 
the satisfaction of the Commissioner that:

[[Page 163]]

    (i) No grant funds have been diverted to any use not in furtherance 
of a purpose specified in the grant;
    (ii) The grant making procedures instituted would have been approved 
if advance approval of such procedures had been properly requested; and
    (iii) Where advance approval of grant making procedures is 
subsequently required, such approval will be properly requested.
    (e) Certain periods--(1) Taxable period. For purposes of section 
4945, the term ``taxable period'' means, with respect to any taxable 
expenditure, the period beginning with the date on which the taxable 
expenditure occurs and ending on the earlier of:
    (i) The date of mailing of a notice of deficiency under section 6212 
with respect to the tax imposed on taxable expenditures by section 
4945(a)(1); or
    (ii) The date on which the tax imposed by section 4945(a)(1) is 
assessed.
    (2) Cross reference. For rules relating to taxable events that are 
corrected within the correction period, defined in section 4963(e), see 
section 4961(a) and the regulations thereunder.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7299, 38 FR 
35305, Dec. 27, 1973; T.D. 7527, 42 FR 64625, Dec. 27, 1977; T.D. 8084, 
51 FR 16303, May 2, 1986]



Sec. 53.4945-2  Propaganda influencing legislation.

    (a) Propaganda influencing legislation, etc.--(1) In general. Under 
section 4945(d)(1) the term ``taxable expenditure'' includes any amount 
paid or incurred by a private foundation to carry on propaganda, or 
otherwise to attempt, to influence legislation. An expenditure is an 
attempt to influence legislation if it is for a direct or grass roots 
lobbying communication, as defined in Sec. 56.4911-2 (without reference 
to Sec. Sec. 56.4911-2(b)(3) and 56.4911-2(c)) and Sec. 56.4911-3. 
See, however, paragraph (d) of this section for exceptions to the 
general rule of this paragraph (a)(1).
    (2) Expenditures for membership communications. Section 56.4911-5, 
which provides special rules for electing public charities' 
communications with their members, does not apply to private 
foundations. Thus, whether a private foundation's communications with 
its members (assuming it has any) are lobbying communications is 
determined solely under Sec. 56.4911-2 and without reference to Sec. 
56.4911-5. However, where a private foundation makes a grant to an 
electing public charity, Sec. 56.4911-5 applies to the electing public 
charity's communications with its own members. Therefore, in the limited 
context of determining whether a private foundation's grant to an 
electing public charity is a taxable expenditure under section 4945, the 
Sec. 56.4911-5 membership rules apply. For example, if the grant is 
specifically earmarked for a communication from the electing public 
charity to its members and the communication is, because of Sec. 
56.4911-5, a nonlobbying communication, the grant is not a taxable 
expenditure under section 4945.
    (3) Jointly funded projects. A private foundation will not be 
treated as having paid or incurred any amount to attempt to influence 
legislation merely because it makes a grant to another organization upon 
the condition that the recipient obtain a matching support appropriation 
from a governmental body. In addition, a private foundation will not be 
treated as having made taxable expenditures of amounts paid or incurred 
in carrying on discussions with officials of governmental bodies 
provided that:
    (i) The subject of such discussions is a program which is jointly 
funded by the foundation and the Government or is a new program which 
may be jointly funded by the foundation and the Government,
    (ii) The discussions are undertaken for the purpose of exchanging 
data and information on the subject matter of the programs, and
    (iii) Such discussions are not undertaken by foundation managers in 
order to make any direct attempt to persuade governmental officials or 
employees to take particular positions on specific legislative issues 
other than such program.
    (4) Certain expenditures by recipients of program-related 
investments. Any amount paid or incurred by a recipient of a program-
related investment (as defined in Sec. 53.4944-3) in connection with

[[Page 164]]

an appearance before, or communication with, any legislative body with 
respect to legislation or proposed legislation of direct interest to 
such recipient shall not be attributed to the investing foundation, if:
    (i) The foundation does not earmark its funds to be used for any 
activities described in section 4945(d) (1) and
    (ii) A deduction under section 162 is allowable to the recipient for 
such amount.
    (5) Grants to public organizations--(i) In general. A grant by a 
private foundation to an organization described in section 509(a) (1), 
(2) or (3) does not constitute a taxable expenditure by the foundation 
under section 4945(d), other than under section 4945(d)(1), if the grant 
by the private foundation is not earmarked to be used for any activity 
described in section 4945(d) (2) or (5), is not earmarked to be used in 
a manner which would violate section 4945(d) (3) or (4), and there does 
not exist an agreement, oral or written, whereby the grantor foundation 
may cause the grantee to engage in any such prohibited activity or to 
select the recipient to which the grant is to be devoted. For purposes 
of this paragraph (a)(5)(i), a grant by a private foundation is 
earmarked if the grant is given pursuant to an agreement, oral or 
written, that the grant will be used for specific purposes. For the 
expenditure responsibility requirements with respect to organizations 
other than those described in section 509(a) (1), (2), or (3), see Sec. 
53.4945-5. For rules for determining whether grants to public charities 
are taxable expenditures under section 4945(d)(1), see paragraphs 
(a)(2), (a)(6) and (a)(7) of this section.
    (ii) Certain ``public'' organizations. For purposes of this section, 
an organization shall be considered a section 509(a)(1) organization if 
it is treated as such under subparagraph (4) of Sec. 53.4945-5(a).
    (6) Grants to public organizations that attempt to influence 
legislation--(i) General support grant. A general support grant by a 
private foundation to the organization described in section 509(a) (1), 
(2), or (3) (a ``public charity'' for purposes of paragraphs (a) (6) and 
(7) of this section) does not constitute a taxable expenditure under 
section 4945(d)(1) to the extent that the grant is not earmarked, within 
the meaning of Sec. 53.4945-2(a)(5)(i), to be used in an attempt to 
influence legislation. The preceding sentence applies without regard to 
whether the public charity has made the election under section 501(h).
    (ii) Specific project grant. A grant, by a private foundation to 
fund a specific project of a public charity is not a taxable expenditure 
by the foundation under section 4945(d)(1) to the extent that--
    (A) The grant is not earmarked, within the meaning of Sec. 53.4945-
2(a)(5)(i), to be used in an attempt to influence legislation, and
    (B) The amount of the grant, together with other grants by the same 
private foundation for the same project for the same year, does not 
exceed the amount budgeted, for the year of the grant, by the grantee 
organization for activities of the project that are not attempts to 
influence legislation. If the grant is for more than one year, the 
preceding sentence applies to each year of the grant with the amount of 
the grant measured by the amount actually disbursed by the private 
foundation in each year or divided equally between years, at the option 
of the private foundation. The same method of measuring the annual 
amount must be used in all years of a grant. This paragraph (a)(6)(ii) 
applies without regard to whether the public charity has made the 
election under section 501(h).
    (iii) Reliance upon grantee's budget. For purposes of determining 
the amount budgeted by a prospective grantee for specific project 
activities that are not attempts to influence legislation under 
paragraph (a)(6)(ii) of this section, a private foundation may rely on 
budget documents or other sufficient evidence supplied by the grantee 
organization (such as a signed statement by an authorized officer, 
director or trustee of such grantee organization) showing the proposed 
budget of the specific project, unless the private foundation doubts or, 
in light of all the facts and circumstances, reasonably should doubt the 
accuracy or reliability of the documents.
    (7) Grants to organizations that cease to be described in 
501(c)(3)--(i) Not taxable expenditure; conditions. A grant to a

[[Page 165]]

public charity (as defined in paragraph (a)(6)(i) of this section) that 
thereafter ceases to be an organization described in section 501(c)(3) 
by reason of its attempts to influence legislation is not a taxable 
expenditure if--
    (A) The grant meets the requirements of paragraph (a)(6) of this 
section,
    (B) The recipient organization had received a ruling or 
determination letter, or an advance ruling or determination letter, that 
it is described in sections 501(c)(3) and 509(a),
    (C) Notice of a change in the recipient organization's status has 
not been made to the public (such as by publication in the Internal 
Revenue Bulletin), and the private foundation has not acquired knowledge 
that the Internal Revenue Service has given notice to the recipient 
organization that it will be deleted from such status; and
    (D) The recipient organization is not controlled directly or 
indirectly by the private foundation. A recipient organization is 
controlled by a private foundation for this purpose if the private 
foundation and disqualified persons (defined in section 4946(a)(1) (A) 
through (H) with reference to the private foundation, by aggregating 
their votes or positions of authority, can cause or prevent action on 
legislative issues by the recipient.
    (ii) Examples. The provisions of paragraphs (a)(6) and (a)(7) of 
this section are illustrated by the following examples:

    Example 1. W, a private foundation, makes a general support grant to 
Z, a public charity described in section 509(a)(1). Z informs W that, as 
an insubstantial portion of its activities, Z attempts to influence the 
State legislature with regard to changes in the mental health laws. The 
use of the grant is not earmarked by W to be used in a manner that would 
violate section 4945(d)(1). Even if the grant is subsequently devoted by 
Z to its legislative activities, the grant by W is not a taxable 
expenditure under section 4945(d).
    Example 2. X, a private foundation, makes a specific project grant 
to Y University for the purpose of conducting research on the potential 
environmental effects of certain pesticides. X does not earmark the 
grant for any purpose that would violate section 4945(d)(1) and there is 
no oral or written agreement or understanding whereby X may cause Y to 
engage in any activity described in section 4945(d) (1), (2), or (5), or 
to select any recipient to which the grant may be devoted. Further, X 
determines, based on budget information supplied by Y, that Y's budget 
for the project does not contain any amount for attempts to influence 
legislation. X has no reason to doubt the accuracy or reliability of the 
budget information. Y uses most of the funds for the research project; 
however, Y expends a portion of the grant funds to send a representative 
to testify at Congressional hearings on a specific bill proposing 
certain pesticide control measures. The portion of the grant funds 
expended with respect to the Congressional hearings is not treated as a 
taxable expenditure by X under section 4945(d)(1).
    Example 3. M, a private foundation, makes a specific project grant 
of $150,000 to P, a public charity described in section 509(a)(1). In 
requesting the grant from M, P stated that the total budgeted cost of 
the project is $200,000, and that of this amount $20,000 is allocated to 
attempts to influence legislation related to the project. M relies on 
the budget figures provided by P in determining the amount P will spend 
on influencing legislation and M has no reason to doubt the accuracy or 
reliability of P's budget figures. In making the grant, M did not 
earmark any of the funds from the grant to be used for attempts to 
influence legislation. M's grant of $150,000 to P will not constitute a 
taxable expenditure under section 4945(d)(1) because M did not earmark 
any of the funds for attempts to influence legislation and because the 
amount of its grant ($150,000) does not exceed the amount allocated to 
specific project activities that are not attempts to influence 
legislation ($200,000-$20,000=$180,000).
    Example 4. Assume the same facts as in example (3), except that M's 
grant letter to P provides that M has the right to renegotiate the terms 
of the grant if there is a substantial deviation from those terms. This 
additional fact does not make M's grant a taxable expenditure under 
section 4945(d)(1).
    Example 5. Assume the same facts as in example (3), except that M 
made a specific project grant of $200,000 to P. Part of M's grant of 
$200,000 will constitute a taxable expenditure under section 4945(d)(1). 
The amount of the grant ($200,000) exceeds by $20,000 the amount P 
allocated to specific project activities that are not attempts to 
influence legislation ($180,000). M has made a taxable expenditure of 
$20,000.
    Example 6. Assume the same facts as example (3), except that M made 
a specific project grant of $180,000, and received from P an enforceable 
commitment that grant funds would not be used in connection with 
attempts to influence legislation. M's grant is not a taxable 
expenditure under section 4945(d)(1).
    Example 7. Assume the same facts as in example (3) except that M 
directed P to hire A, an individual, to expend $20,000 from the

[[Page 166]]

grant to engage in direct lobbying (within the meaning of Sec. 56.4911-
2(b)) and grass roots lobbying (within the meaning of Sec. 56.4911-
2(c)). P does not expend any other grant funds for lobbying activities. 
The $20,000 that is earmarked for direct lobbying and grass roots 
lobbying is a taxable expenditure under section 4945(d)(1).
    Example 8. R, a public charity described in section 509(a)(1), 
requested N, a private foundation, to make a general purpose grant to it 
to aid R in carrying out its exempt purpose. In making this request, R 
notified N that it had elected the expenditure test under section 501(h) 
and that it expected to attempt to influence legislation in areas 
related to its exempt purpose. Since its formation, R generally has had 
exempt purpose expenditures (as defined in Sec. 56.4911-4) in excess of 
$7,000,000 in each of its taxable years, and has budgeted in excess of 
$7,000,000 of exempt purpose expenditures for the year of the grant. N 
made a grant of $200,000 to R. N did not earmark the funds for R's 
attempt to influence legislation. The general purpose grant by N does 
not constitute a taxable expenditure under section 4945(d)(1).
    Example 9. Assume the same facts as in example (8), except that N 
learns that R has had excess lobbying expenditures (within the meaning 
of Sec. 56.4911-1(b)) in some prior years. N also learns that in no 
year has R's lobbying or grass roots expenditures (within the meaning of 
Sec. 56.4911-2 (a) and (c)) exceeded the corresponding ceiling amount 
(within the meaning of Sec. 1.501(h)-3(c) (3) and (6)). N then makes 
the grant to R. After receiving the grant, R spends a large portion of 
its funds on influencing legislation and, as a consequence, is denied 
exemption from tax, as an organization described in section 501(c)(3), 
under section 501(h) and Sec. 1.501(h)-3. No disqualified person with 
respect to N controlled, in whole or in part, R's attempts to influence 
legislation. The general purpose grant will not constitute a taxable 
expenditure under section 4945(d)(1).
    Example 10. X, a private foundation, makes a specific project grant 
to Y, a public charity described in section 509(a). In requesting the 
grant, Y stated that it planned to use the funds to purchase a computer 
for purpose of computerizing its research files and that the grant will 
not be used to influence legislation. Two years after X makes the grant, 
X discovers that Y has also used the computer for purposes of 
maintaining and updating the mailing list for Y's lobbying newsletter. 
Because X did not earmark any of the grant funds to be used for attempts 
to influence legislation and because X had no reason to doubt the 
accuracy or reliability of Y's documents representing that the grant 
would not be used to influence legislation, X's grant is not treated as 
a taxable expenditure.
    Example 11. G, a private foundation, makes a specific project grant 
of $300,000 to L, a public charity described in section 509(a)(1) for a 
three-year specific project studying child care problems. L provides 
budget material indicating that the specific project will expend 
$200,000 in each of three years. L's budget materials indicate that 
attempts to influence legislation will amount to $10,000 in the first 
year, $20,000 in the second year and $100,000 in the third year. G 
intends to pay its $300,000 grant over three years as follows: $200,000 
in the first year, $50,000 in the second year and $50,000 in the third 
year. The amount of the grant actually disbursed by G in the first year 
of the grant exceeds the nonlobbying expenditures of L in that year. 
However, because the amount of the grant in each of the three years, 
when divided equally among the three years ($100,000 for each year), is 
not more than the nonlobbying expenditures of L on the specific project 
for any of the three years, none of the grant is treated as a taxable 
expenditure under section 4945(d)(1).
    Example 12. P, a private foundation, makes a $120,000 specific 
project grant to C, a public charity described in section 509(a) for a 
three-year project. P intends to pay its grant to C in three equal 
annual installments of $40,000. C provides budget material indicating 
that the specific project will expend $100,000 in each of three years. 
C's budget materials, which P reasonably does not doubt, indicate that 
the project's attempts to influence legislation will amount to $50,000 
in each of the three years. After P pays the first annual installment to 
C, but before P pays the second installment to C, reliable information 
comes to P's attention that C has spent $90,000 of the project's 
$100,000 first-year budget on attempts to influence legislation. This 
information causes P to doubt the accuracy and reliability of C's budget 
materials. Because of the information, P does not pay the second-year 
installment to C. P's payment of the first installment of $40,000 is not 
a taxable expenditure under section 4945(d)(1) because the grant in the 
first year is not more than the nonlobbying expenditures C projected in 
its budget materials that P reasonably did not doubt.
    Example 13. Assume the same facts as in Example (12), except that P 
pays the second-year installment of $40,000 to C. In the project's 
second year, C once again spends $90,000 of the project's $100,000 
annual budget in attempts to influence legislation. Because P doubts or 
reasonably should doubt the accuracy or reliability of C's budget 
materials when P makes the second-year grant payment, P may not rely 
upon C's budget documents at that time. Accordingly, although none of 
the $40,000 paid in the first installment is a taxable expenditure, only 
$10,000 ($100,000 minus $90,000) of the second-year grant payment is not 
a taxable expenditure.

[[Page 167]]

The remaining $30,000 of the second installment is a taxable expenditure 
within the meaning of section 4945(d)(1).
    Example 14. B, a private foundation, makes a specific project grant 
to C, a public charity described in section 509(a), of $40,000 for the 
purpose of conducting a study on the effectiveness of seat belts in 
preventing traffic deaths. B did not earmark any of the grant for 
attempts to influence legislation. In requesting the grant from B, C 
submitted a budget of $100,000 for the project. The budget contained 
expenses for postage and mailing, computer time, advertising, consulting 
services, salaries, printing, advertising, and similar categories of 
expenses. C also submitted to B a statement, signed by an officer of C, 
that 30% of the budgeted funds would be devoted to attempts to influence 
legislation within the meaning of section 4945. B has no reason to doubt 
the accuracy of the budget figures or the statement. B may rely on the 
budget figures and signed statement provided by C in determining the 
amount C will spend on influencing legislation. B's grant to C will not 
constitute a taxable expenditure under section 4945(d)(1), because the 
amount of the grant does not exceed the amount allocated to specific 
project activities that are not attempts to influence legislation.

    (b)-(c) [Reserved]
    (d) Exceptions--(1) Nonpartisan analysis, study, or research--(i) In 
general. A communication is not a lobbying communication, for purposes 
of Sec. 53.4945-2(a)(1), if the communication constitutes engaging in 
nonpartisan analysis, study or research and making available to the 
general public or a segment or members thereof or to governmental 
bodies, officials, or employees the results of such work. Accordingly, 
an expenditure for such a communication does not constitute a taxable 
expenditure under section 4945(d)(1) and Sec. 53.4945-2(a)(1).
    (ii) Nonpartisan analysis, study, or research. For purposes of 
section 4945(e), ``nonpartisan analysis, study, or research'' means an 
independent and objective exposition of a particular subject matter, 
including any activity that is ``educational'' within the meaning of 
Sec. 1.501(c)(3)-1(d)(3). Thus, ``nonpartisan analysis, study, or 
research'' may advocate a particular position or viewpoint so long as 
there is a sufficiently full and fair exposition of the pertinent facts 
to enable the public or an individual to form an independent opinion or 
conclusion. On the other hand, the mere presentation of unsupported 
opinion does not qualify as ``nonpartisan analysis, study, or 
research''.
    (iii) Presentation as part of a series. Normally, whether a 
publication or broadcast qualifies as ``nonpartisan analysis, study, or 
research'' will be determined on a presentation-by-presentation basis. 
However, if a publication or broadcast is one of a series prepared or 
supported by a private foundation and the series as a whole meets the 
standards of subdivision (ii) of this subparagraph, then any individual 
publication or broadcast within the series will not result in a taxable 
expenditure even though such individual broadcast or publication does 
not, by itself, meet the standards of subdivision (ii) of this 
subparagraph. Whether a broadcast or publication is considered part of a 
series will ordinarily depend on all the facts and circumstances of each 
particular situation. However, with respect to broadcast activities, all 
broadcasts within any period of 6 consecutive months will ordinarily be 
eligible to be considered as part of a series. If a private foundation 
times or channels a part of a series which is described in this 
subdivision in a manner designed to influence the general public or the 
action of a legislative body with respect to a specific legislative 
proposal in violation of section 4945(d)(1), the expenses of preparing 
and distributing such part of the analysis, study, or research will be a 
taxable expenditure under this section.
    (iv) Making available results of analysis, study, or research. A 
private foundation may choose any suitable means, including oral or 
written presentations, to distribute the results of its nonpartisan 
analysis, study, or research, with or without charge. Such means include 
distribution of reprints of speeches, articles, and reports (including 
the report required under section 6056); presentation of information 
through conferences, meetings, and discussions; and dissemination to the 
news media, including radio, television, and newspapers, and to other 
public forums. For purposes of this

[[Page 168]]

paragraph (d)(1)(iv), such communications may not be limited to, or be 
directed toward, persons who are interested solely in one side of a 
particular issue.
    (v) Subsequent lobbying use of certain analysis, study, or 
research--(A) In general. Even though certain analysis, study or 
research is initially within the exception for nonpartisan analysis, 
study, or research, subsequent use of that analysis, study or research 
for grass roots lobbying may cause that analysis, study or research to 
be treated as a grass roots lobbying communication that is not within 
the exception for nonpartisan analysis, study, or research. This 
paragraph (d)(1)(v) of this section does not cause any analysis, study, 
or research to be considered a direct lobbying communication. For rules 
regarding when analysis, study, or research is treated as a grass roots 
lobbying communication that is not within the scope of the exception for 
nonpartisan analysis, study, or research, see Sec. 56.4911-2(b)(2)(v).
    (B) Special rule for grants to public charities. This paragraph 
(d)(1)(v)(B) of this section applies where a public charity uses a 
private foundation grant to finance, in whole or in part, a nonlobbying 
communication that is subsequently used in lobbying, causing the public 
charity's expenditures for the communication to be treated as lobbying 
expenditures under the subsequent use. In such a case, the private 
foundation's grant will ordinarily not be characterized as a lobbying 
expenditure by virtue of the subsequent use rule. The only situations 
where the private foundation's grant will be treated as a lobbying 
expenditure under the subsequent use rule are where the private 
foundation's primary purpose in making the grant to the public charity 
was for lobbying or where, at the time of making the grant, the private 
foundation knows (or in light of all the facts and circumstances 
reasonably should know) that the public charity's primary purpose in 
preparing the communication to be funded by the grant is for use in 
lobbying.
    (vi) Directly encouraging action by recipients of a communication. A 
communication that reflects a view on specific legislation is not within 
the nonpartisan analysis, study, or research exception of this Sec. 
53.4945-2(d)(1) if the communication directly encourages the recipient 
to take action with respect to such legislation. For purposes of this 
section, a communication directly encourages the recipient to take 
action with respect to legislation if the communication is described in 
one or more of Sec. 56.4911-2(b)(2)(iii)(A) through (C). As described 
in Sec. 56.4911-2(b)(2)(iv), a communication would encourage the 
recipient to take action with respect to legislation, but not directly 
encourage such action, if the communication does no more than 
specifically identify one or more legislators who will vote on the 
legislation as: opposing the communication's view with respect to the 
legislation; being undecided with respect to the legislation; being the 
recipient's representative in the legislature; or being a member of the 
legislative committee or subcommittee that will consider the 
legislation.
    (vii) Examples. The provisions of this paragraph may be illustrated 
by the following examples:

    Example 1. M, a private foundation, establishes a research project 
to collect information for the purpose of showing the dangers of the use 
of pesticides in raising crops. The information collected includes data 
with respect to proposed legislation, pending before several State 
legislatures, which would ban the use of pesticides. The project takes 
favorable positions on such legislation without producing a sufficiently 
full and fair exposition of the pertinent facts to enable the public or 
an individual to form an independent opinion or conclusion on the pros 
and cons of the use of pesticides. This project is not within the 
exception for nonpartisan analysis, study, or research because it is 
designed to present information merely on one side of the legislative 
controversy.
    Example 2. N, a private foundation, establishes a research project 
to collect information concerning the dangers of the use of pesticides 
in raising crops for the ostensible purpose of examining and reporting 
information as to the pros and cons of the use of pesticides in raising 
crops. The information is collected and distributed in the form of a 
published report which analyzes the effects and costs of the use and 
nonuse of various pesticides under various conditions on humans, 
animals, and crops. The report also presents the advantages, 
disadvantages, and economic cost of allowing the continued use of 
pesticides unabated, of controlling the use of pesticides, and of 
developing alternatives to pesticides. Even if the report sets forth

[[Page 169]]

conclusions that the disadvantages as a result of using pesticides are 
greater than the advantages of using pesticides and that prompt 
legislative regulation of the use of pesticides is needed, the project 
is within the exception for nonpartisan analysis, study or research 
since it is designed to present information on both sides of the 
legislative controversy and presents a sufficiently full and fair 
exposition of the pertinent facts to enable the public or an individual 
to form an independent opinion or conclusion.
    Example 3. O, a private foundation, establishes a research project 
to collect information on the presence or absence of disease in humans 
from eating food grown with pesticides and the presence or absence of 
disease in humans from eating food not grown with pesticides. As part of 
the research project, O hires a consultant who prepares a ``fact sheet'' 
which calls for the curtailment of the use of pesticides and which 
addresses itself to the merits of several specific legislative proposals 
to curtail the use of pesticides in raising crops which are currently 
pending before State legislatures. The ``fact sheet'' presents reports 
of experimental evidence tending to support its conclusions but omits 
any reference to reports of experimental evidence tending to dispute its 
conclusions. O distributes 10,000 copies to citizens' groups. 
Expenditures by O in connection with this work of the consultant are not 
within the exception for nonpartisan analysis, study, or research.
    Example 4. P publishes a bi-monthly newsletter to collect and report 
all published materials, ongoing research, and new developments with 
regard to the use of pesticides in raising crops. The newsletter also 
includes notices of proposed pesticide legislation with impartial 
summaries of the provisions and debates on such legislation. The 
newsletter does not encourage recipients to take action with respect to 
such legislation, but is designed to present information on both sides 
of the legislative controversy and does present information fully and 
fairly. It is within the exception for nonpartisan analysis, study, or 
research.
    Example 5. X is satisfied that A, a member of the faculty of Y 
University, is exceptionally well qualified to undertake a project 
involving a comprehensive study of the effects of pesticides on crop 
yields. Consequently, X makes a grant to A to underwrite the cost of the 
study and of the preparation of a book on the effect of pesticides on 
crop yields. X does not take any position on the issues or control the 
content of A's output. A produces a book which concludes that the use of 
pesticides often has a favorable effect on crop yields, and on that 
basis argues against pending bills which would ban the use of 
pesticides. A's book contains a sufficiently full and fair exposition of 
the pertinent facts, including known or potential disadvantages of the 
use of pesticides, to enable the public or an individual to form an 
independent opinion or conclusion as to whether pesticides should be 
banned as provided in the pending bills. The book does not directly 
encourage readers to take action with respect to the pending bills. 
Consequently, the book is within the exception for nonpartisan analysis, 
study, or research.
    Example 6. Assume the same facts as Example (2), except that, 
instead of issuing a report, X presents within a period of 6 consecutive 
months a two-program television series relating to the pesticide issue. 
The first program contains information, arguments, and conclusions 
favoring legislation to restrict the use of pesticides. The second 
program contains information, arguments, and conclusions opposing 
legislation to restrict the use of pesticides. The programs are 
broadcast within 6 months of each other during commensurate periods of 
prime time. X's programs are within the exception for nonpartisan 
analysis, study, or research. Although neither program individually 
could be regarded as nonpartisan, the series of two programs constitutes 
a balanced presentation.
    Example 7. Assume the same facts as Example (6), except that X 
arranged for televising the program favoring legislation to restrict the 
use of pesticides at 8 p.m. on a Thursday evening and for televising the 
program opposing such legislation at 7 a.m. on a Sunday morning. X's 
presentation is not within the exception for nonpartisan analysis, 
study, or research, since X disseminated its information in a manner 
prejudicial to one side of the legislative controversy.
    Example 8. Organization Z researches, writes, prints and distributes 
a study on the use and effects of pesticide X. A bill is pending in the 
U.S. Senate to ban the use of pesticide X. Z's study leads to the 
conclusion that pesticide X is extremely harmful and that the bill 
pending in the U.S. Senate is an appropriate and much needed remedy to 
solve the problems caused by pesticide X. The study contains a 
sufficiently full and fair exposition of the pertinent facts, including 
known or potential advantages of the use of pesticide X, to enable the 
public or an individual to form an independent opinion or conclusion as 
to whether pesticides should be banned as provided in the pending bills. 
In its analysis of the pending bill, the study names certain undecided 
Senators on the Senate committee considering the bill. Although the 
study meets the three part test for determining whether a communication 
is a grass roots lobbying communication, the study is within the 
exception for nonpartisan analysis, study or research, because it does 
not directly encourage recipients of the communication to urge a 
legislator to oppose the bill.
    Example 9. Assume the same facts as in Example (8), except that, 
after stating support

[[Page 170]]

for the pending bill, the study concludes: ``You should write to the 
undecided committee members to support this crucial bill.'' The study is 
not within the exception for nonpartisan analysis, study or research 
because it directly encourages the recipients to urge a legislator to 
support a specific piece of legislation.
    Example 10. Organization X plans to conduct a lobbying campaign with 
respect to illegal drug use in the United States. It incurs $5,000 in 
expenses to conduct research and prepare an extensive report primarily 
for use in the lobbying campaign. Although the detailed report discusses 
specific pending legislation and reaches the conclusion that the 
legislation would reduce illegal drug use, the report contains a 
sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent conclusion regarding 
the effect of the legislation. The report does not encourage readers to 
contact legislators regarding the legislation. Accordingly, the report 
does not, in and of itself, constitute a lobbying communication.
    Copies of the report are available to the public at X's office, but 
X does not actively distribute the report or otherwise seek to make the 
contents of the report available to the general public. Whether or not 
X's distribution is sufficient to meet the requirement in Sec. 53.4945-
2(d)(1)(iv) that a nonpartisan communication be made available, X's 
distribution is not substantial (for purposes of Sec. Sec. 53.4945-
2(D)(1)(v) and 56.4911-2(b)(2)(v)) in light of all of the facts and 
circumstances, including the normal distribution pattern of similar 
nonpartisan reports. X then mails copies of the report, along with a 
letter, to 10,000 individuals on X's mailing list. In the letter, X 
requests that individuals contact legislators urging passage of the 
legislation discussed in the report. Because X's research and report 
were primarily undertaken by X for lobbying purposes and X did not make 
a substantial distribution of the report (without an accompanying 
lobbying message) prior to or contemporaneously with the use of the 
report in lobbying, the report is a grass roots lobbying communication 
that is not within the exception for nonpartisan analysis, study or 
research. Thus, the expenditures for preparing and mailing both the 
report and the letter are taxable expenditures under section 4945.
    Example 11. Assume the same facts as in Example (10), except that 
before using the report in the lobbying campaign, X sends the research 
and report (without an accompanying lobbying message) to universities 
and newspapers. At the same time, X also advertises the availability of 
the report in its newsletter. This distribution is similar in scope to 
the normal distribution pattern of similar nonpartisan reports. In light 
of all of the facts and circumstances, X's distribution of the report is 
substantial. Because of X's substantial distribution of the report, X's 
primary purpose will be considered to be other than for use in lobbying 
and the report will not be considered a grass roots lobbying 
communication. Accordingly, only the expenditures for copying and 
mailing the report to the 10,000 individuals on X's mailing list, as 
well as for preparing and mailing the letter, are expenditures for grass 
roots lobbying communications, and are thus taxable expenditures under 
section 4945.
    Example 12. Organization M pays for a bumper sticker that reads: 
``STOP ABORTION: Vote NO on Prop. X!'' M also pays for a 30-second 
television advertisement and a billboard that similarly advocate 
opposition to Prop. X. In light of the limited scope of the 
communications, none of the communications is within the exception for 
nonpartisan analysis, study or research. First, none of the 
communications rises to the level of analysis, study or research. 
Second, none of the communications is nonpartisan because none contains 
a sufficiently full and fair exposition of the pertinent facts to enable 
the public or an individual to form an independent opinion or 
conclusion. Thus, each communication is a lobbying communication.

    (2) Technical advice or assistance--(i) In general. Amounts paid or 
incurred in connection with providing technical advice or assistance to 
a governmental body, a governmental committee, or a subdivision of 
either of the foregoing, in response to a written request by such body, 
committee, or subdivision do not constitute taxable expenditures for 
purposes of this section. Under this exception, the request for 
assistance or advice must be made in the name of the requesting 
governmental body, committee or subdivision rather than an individual 
member thereof. Similarly, the response to such request must be 
available to every member of the requesting body, committee or 
subdivision. For example, in the case of a written response to a request 
for technical advice or assistance from a congressional committee, the 
response will be considered available to every member of the requesting 
committee if the response is submitted to the person making such request 
in the name of the committee and it is made clear that the response is 
for the use of all the members of the committee.
    (ii) Nature of technical advice or assistance. ``Technical advice or 
assistance'' may be given as a result of knowledge

[[Page 171]]

or skill in a given area. Because such assistance or advice may be given 
only at the express request of a governmental body, committee or 
subdivision, the oral or written presentation of such assistance or 
advice need not qualify as nonpartisan analysis, study or research. The 
offering of opinions or recommendations will ordinarily qualify under 
this exception only if such opinions or recommendations are specifically 
requested by the governmental body, committee or subdivision or are 
directly related to the materials so requested.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A congressional committee is studying the feasibility of 
legislation to provide funds for scholarships to U.S. students attending 
schools abroad. X, a private foundation which has engaged in a private 
scholarship program of this type, is asked, in writing, by the committee 
to describe the manner in which it selects candidates for its program. 
X's response disclosing its methods of selection constitutes technical 
advice or assistance.
    Example 2. Assume the same facts as Example (1), except that X's 
response not only includes a description of its own grant-making 
procedures, but also its views regarding the wisdom of adopting such a 
program. Since such views are directly related to the subject matter of 
the request for technical advice or assistance, expenditures paid or 
incurred with respect to the presentation of such views would not 
constitute taxable expenditures. However, expenditures paid or incurred 
with respect to a response which is not directly related to the subject 
matter of the request for technical advice or assistance would 
constitute taxable expenditures unless the presentation can qualify as 
the making available of nonpartisan analysis, study or research.
    Example 3. Assume the same facts as Example (1), except that X is 
requested, in addition, to give any views it considers relevant. A 
response to this request giving opinions which are relevant to the 
committee's consideration of the scholarship program but which are not 
necessarily directly related to X's scholarship program, such as 
discussions of alternative scholarships programs and their relative 
merits, would qualify as ``technical advice or assistance'', and 
expenditures paid or incurred with respect to such response would not 
constitute taxable expenditures.
    Example 4. A, an official of the State Department, makes a written 
request in his official capacity for information from foundation Y 
relating to the economic development of country M and for the opinions 
of Y as to the proper position of the United States in pending 
negotiations with M concerning a proposed treaty involving a program of 
economic and technical aid to M. Y's furnishing of such information and 
opinions constitutes technical advice or assistance.
    Example 5. In response to a telephone inquiry from Senator X's 
staff, organization B sends Senator X a report concluding that the 
Senate should not advise and consent to the nomination of Z to serve as 
a Supreme Court Justice. Because the request was not in writing, and 
also because the request was not from the Senate itself or from a 
committee or subcommittee, B's report is not within the scope of the 
exception for responses to requests for technical advice. Accordingly, 
B's report is a lobbying communication unless the report is within the 
scope of the exception for nonpartisan analysis, study or research.
    Example 6. Assume the same facts as in Example (5), except that B's 
report is sent in response to a written request that Senator X sends to 
B. The request from Senator X is a request from the Senator as an 
individual member of the Senate rather than from the Senate itself or 
from a committee or subcommittee. Accordingly, B's report is not within 
the scope of the exception for responses to requests for technical 
advice and is a lobbying conmmunication unless the report is within the 
scope of the exception for nonpartisan analysis, study or research.
    Example 7. Assume the same facts as in Example (6), except that B's 
report is sent in response to a written request from the Senate 
committee that is considering the nomination for an evaluation of the 
nominee's legal writings and a recommendation as to whether the 
candidate is or is not qualified to serve on the Supreme Court. The 
report is within the scope of the exception for responses to requests 
for technical advice and is not a lobbying communication.

    (3) Decisions affecting the powers, duties, etc., of a private 
foundation--(i) In general. Paragraph (c) of this section does not apply 
to any amount paid or incurred in connection with an appearance before, 
or communication with, any legislative body with respect to a possible 
decision of such body which might affect the existence of the private 
foundation, its powers and duties, its tax-exempt status, or the 
deductibility of contributions to such foundation. Under this exception, 
a foundation may communicate with the entire legislative body, 
committees or subcommittees of such legislative body, individual 
congressmen or legislators,

[[Page 172]]

members of their staffs, or representatives of the executive branch, who 
are involved in the legislative process, if such communication is 
limited to the prescribed subjects. Similarly, the foundation may make 
expenditures in order to initiate legislation if such legislation 
concerns only matters which might affect the existence of the private 
foundation, its powers and duties, its tax-exempt status, or the 
deductibility of contributions to such foundation.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. A bill is being considered by Congress which would, if 
enacted, restrict the power of a private foundation to engage in 
transactions with certain related persons. Under the proposed bill a 
private foundation would lose its exemption from taxation if it engages 
in such transactions. W, a private foundation, writes to the 
congressional committee considering the bill, arguing that the enactment 
of such a bill would not be advisable, and subsequently appears before 
such committee to make its arguments. In addition, W requests that the 
congressional committee consider modification of the 2 percent de 
minimis rule of section 4943(c) (2) (C). Expenditures paid or incurred 
with respect to such submissions do not constitute taxable expenditures 
since they are made with respect to a possible decision of Congress 
which might affect the existence of the private foundation, its powers 
and duties, its tax-exempt status, or the deduction of contributions to 
such foundation.
    Example 2. A bill being considered in a State legislature is 
designed to implement the requirements of section 508(e) of the Internal 
Revenue Code of 1954. Under such section, a private foundation is 
required to make certain amendments to its governing instrument. X, a 
private foundation, makes a submission to the legislature which proposes 
alternative measures which might be taken in lieu of the proposed bill. 
X also arranges to have its president contact certain State legislators 
with regard to this bill. Expenditures paid or incurred in making such 
submission and in contacting the State legislators do not constitute 
taxable expenditures since they are made with respect to a possible 
decision of such State legislature which might affect the existence of 
the private foundation, its powers and duties, its tax-exempt status, or 
the deduction of contributions to such foundation.
    Example 3. A bill is being considered by a State legislature under 
which the State would assume certain responsibilities for nursing care 
of the aged. Y, a private foundation which hitherto has engaged in such 
activities, appears before the State legislature and contends that such 
activities can be better performed by privately supported organizations. 
Expenditures paid or incurred with respect to such appearance are not 
made with respect to possible decisions of the State legislature which 
might affect the existence of the private foundation, its powers and 
duties, its tax-exempt status, or the deduction of contributions to such 
foundation, but rather merely affect the scope of the private 
foundation's future activities.
    Example 4. A State legislature is considering the annual 
appropriations bill. Z, a private foundation which had hitherto 
performed contract research for the State, appears before the 
appropriations committee in order to attempt to persuade the committee 
of the advisability of continuing the program. Expenditures paid or 
incurred with respect to such appearance are not made with respect to 
possible decisions of the State legislature which might affect the 
existence of the private foundation, its powers and duties, its tax-
exempt status, or the deduction of contributions to such foundation, but 
rather merely affect the scope of the private foundation's future 
activities.

    (4) Examination and discussions of broad social, economic, and 
similar problems. Examinations and discussions of broad social, 
economic, and similar problems are neither direct lobbying 
communications under Sec. 56.4911-2(b)(1) nor grass roots lobbying 
communications under Sec. 56.4911-2(b)(2) even if the problems are of 
the type with which government would be expected to deal ultimately. 
Thus, under Sec. Sec. 56.4911-2(b) (1) and (2), lobbying communications 
do not include public discussion, or communications with members of 
legislative bodies or governmental employees, the general subject of 
which is also the subject of legislation before a legislative body, so 
long as such discussion does not address itself to the merits of a 
specific legislative proposal and so long as such discussion does not 
directly encourage recipients to take action with respect to 
legislation. For example, this paragraph (d)(4) excludes from grass 
roots lobbying under Sec. 56.4911(b)(2) an organization's discussions 
of problems such as environmental pollution or population growth that 
are being considered by Congress and various State legislatures, but 
only where the discussions are not directly addressed to specific 
legislation being considered, and only where the

[[Page 173]]

discussions do not directly encourage recipients of the communication to 
contact a legislator, an employee of a legislative body, or a government 
official or employee who may participate in the formulation of 
legislation.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972, as 
amended by T.D. 8308, 55 FR 35594, Aug. 31, 1990]



Sec. 53.4945-3  Influencing elections and carrying on voter registration drives.

    (a) Expenditures to influence elections or carry on voter 
registration drives--(1) In general. Under section 4945(d) (2), the term 
``taxable expenditure'' includes any amount paid or incurred by a 
private foundation to influence the outcome of any specific public 
election or to carry on, directly or indirectly, any voter registration 
drive, unless such amount is paid or incurred by an organization 
described in section 4945(f). However, for treatment of nonearmarked 
grants to public organizations, see Sec. 53.4945-2(a) (5) and for 
treatment of certain earmarked grants to organizations described in 
section 4945(f), see paragraph (b) (2) of this section.
    (2) Influencing the outcome of a specific public election. For 
purposes of this section, an organization shall be considered to be 
influencing the outcome of any specific public election if it 
participates or intervenes, directly or indirectly, in any political 
campaign on behalf of or in opposition to any candidate for public 
office. The term candidate for public office means an individual who 
offers himself, or is proposed by others, as a contestant for an 
elective public office, whether such office be national, State or local. 
Activities which constitute participation or intervention in a political 
campaign on behalf of or in opposition to a candidate include, but are 
not limited to:
    (i) Publishing or distributing written or printed statements or 
making oral statements on behalf of or in opposition to such a 
candidate;
    (ii) Paying salaries or expenses of campaign workers; and
    (iii) Conducting or paying the expenses of conducting a voter-
registration drive limited to the geographic area covered by the 
campaign.
    (b) Nonpartisan activities carried on by certain organizations--(1) 
In general. If an organization meets the requirements described in 
section 4945(f), an amount paid or incurred by such organization shall 
not be considered a taxable expenditure even though the use of such 
amount is otherwise described in section 4945(d) (2). Such requirements 
are:
    (i) The organization is described in section 501(c) (3) and exempt 
from taxation under section 501(a);
    (ii) The activities of the organization are nonpartisan, are not 
confined to one specific election period, and are carried on in five or 
more States;
    (iii) The organization expends at least 85 percent of its income 
directly for the active conduct (within the meaning of section 4942(j) 
(3) and the regulations thereunder) of the activities constituting the 
purpose or function for which it is organized and operated;
    (iv) The organization receives at least 85 percent of its support 
(other than gross investment income as defined in section 509(e)) from 
exempt organizations, the general public, governmental units described 
in section 170(c) (1), or any combination of the foregoing; the 
organization does not receive more than 25 percent of its support (other 
than gross investment income) from any one exempt organization (for this 
purpose treating private foundations which are described in section 
4946(a) (1) (H) with respect to each other as one exempt organization); 
and not more than half of the support of the organization is received 
from gross investment income; and
    (v) Contributions to the organization for voter registration drives 
are not subject to conditions that they may be used only in specified 
States, possessions of the United States, or political subdivisions or 
other areas of any of the foregoing, or the District of Columbia, or 
that they may be used in only one specific election period.
    (2) Grants to section 4945(f) organizations. If a private foundation 
makes a grant to an organization described in section 4945(f) (whether 
or not such grantee is a private foundation as defined in section 
509(a)), such grant will not be treated as a taxable expenditure

[[Page 174]]

under section 4945(d) (2) or (4). Even if a grant to such an 
organization is earmarked for voter registration purposes generally, 
such a grant will not be treated as a taxable expenditure under section 
4945(d) (2) or (4) as long as such earmarking does not violate section 
4945(f) (5).
    (3) Period for determining support--(i) In general. The 
determination whether an organization meets the support test in section 
4945(f) (4) for any taxable year is to be made by aggregating all 
amounts of support received by the organization during the taxable year 
and the immediately preceding four taxable years. However, the support 
received in any taxable year which begins before January 1, 1970, shall 
be excluded.
    (ii) New organizations and organizations with no preceding taxable 
years beginning after December 31, 1969. Except as provided in 
subparagraph (4) of this paragraph, in the case of a new organization or 
an organization with no taxable years that begin after December 31, 
1969, and immediately precede the taxable year in question, the 
requirements of the support test in section 4945(f)(4) will be 
considered as met for the taxable year if such requirements are met by 
the end of the taxable year.
    (iii) Organization with three or fewer preceding taxable years. In 
the case of an organization which has been in existence for at least 1 
but fewer than 4 preceding taxable years beginning after December 31, 
1969, the determination whether such organization meets the requirements 
of the support test in section 4945(f)(4) for the taxable year is to be 
made by taking into account all the support received by such 
organization during the taxable year and during each preceding taxable 
year beginning after December 31, 1969.
    (4) Advance rulings. An organization will be given an advance ruling 
that it is an organization described in section 4945(f) for its first 
taxable year of operation beginning after October 30, 1972, or for its 
first taxable year of operation beginning after December 31, 1969, if it 
submits evidence establishing that it can reasonably be expected to meet 
the tests under section 4945(f) for such taxable year. An organization 
which, pursuant to this subparagraph, has been treated as an 
organization described in section 4945(f) for a taxable year (without 
withdrawal of such treatment by notification from the Internal Revenue 
Service during such year), but which actually fails to meet the 
requirements of section 4945(f) for such taxable year, will not be 
treated as an organization described in section 4945(f) as of the first 
day of its next taxable year (for purposes of making any determination 
under the internal revenue laws with respect to such organization) and 
until such time as the organization does meet the requirements of 
section 4945(f). For purposes of section 4945, the status of grants or 
contributions with respect to grantors or contributors to such 
organization will not be affected until notice of change of status of 
such organization is made to the public (such as by publication in the 
Internal Revenue Bulletin). The preceding sentence shall not apply, 
however, if the grantor or contributor was responsible for, or was aware 
of, the fact that the organization did not satisfy section 4945(f) at 
the end of the taxable year with respect to which the organization had 
obtained an advance ruling or a determination letter that it was a 
section 4945(f) organization, or acquired knowledge that the Internal 
Revenue Service had given notice to such organization that it would be 
deleted from classification as a section 4945(f) organization.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 11, 1972]



Sec. 53.4945-4  Grants to individuals.

    (a) Grants to individuals--(1) In general. Under section 4945(d) (3) 
the term ``taxable expenditure'' includes any amount paid or incurred by 
a private foundation as a grant to an individual for travel, study, or 
other similar purposes by such individual unless the grant satisfies the 
requirements of section 4945(g). Grants to individuals which are not 
taxable expenditures because made in accordance with the requirements of 
section 4945(g) may result in the imposition of excise taxes under other 
provisions of chapter 42.
    (2) ``Grants'' defined. For purposes of section 4945, the term 
``grants'' shall include, but is not limited to, such expenditures as 
scholarships, fellowships, internships, prizes, and awards. Grants

[[Page 175]]

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). Similarly, ``grants'' include such 
expenditures as payments to exempt organizations to be used in 
furtherance of such recipient organizations' exempt purposes whether or 
not such payments are solicited by such recipient organizations. 
Conversely, ``grants'' do not ordinarily include salaries or other 
compensation to employees. For example, ``grants'' do not ordinarily 
include educational payments to employees which are includible in the 
employees' incomes pursuant to section 61. In addition, ``grants'' do 
not ordinarily include payments (including salaries, consultants' fees 
and reimbursement for travel expenses such as transportation, board, and 
lodging) to persons (regardless of whether such persons are individuals) 
for personal services in assisting a foundation in planning, evaluating 
or developing projects or areas of program activity by consulting, 
advising, or participating in conferences organized by the foundation.
    (3) Requirements for individual grants--(i) Grants for other than 
section 4945(d)(3) purposes. A grant to an individual for purposes other 
than those described in section 4945(d) (3) is not a taxable expenditure 
within the meaning of section 4945(d) (3). For example, if a foundation 
makes grants to indigent individuals to enable them to purchase 
furniture, such grants are not taxable expenditures within the meaning 
of section 4945(d) (3) even if the requirements of section 4945(g) are 
not met.
    (ii) Grants for section 4945(d) (3) purposes. Under section 4945(g), 
a grant to an individual for travel, study, or other similar purposes is 
not a ``taxable expenditure'' only if:
    (a) The grant is awarded on an objective and nondiscriminatory basis 
(within the meaning of paragraph (b) of this section);
    (b) The grant is made pursuant to a procedure approved in advance by 
the Commissioner; and
    (c) It is demonstrated to the satisfaction of the Commissioner that:
    (1) The grant constitutes a scholarship or fellowship grant which is 
excluded from gross income under section 117(a) and is to be utilized 
for study at an educational institution described in section 151(e) (4);
    (2) The grant constitutes a prize or award which is excluded from 
gross income under section 74(b), and the recipient of such prize or 
award is selected from the general public (within the meaning of section 
4941(d) (2) (G) (i) and the regulations thereunder); or
    (3) The purpose of the grant is to achieve a specific objective, 
produce a report or other similar product, or improve or enhance a 
literary, artistic, musical, scientific, teaching, or other similar 
capacity, skill, or talent of the grantee.


If a grant is made to an individual for a purpose described in section 
4945(g) (3) and such grant otherwise meets the requirements of section 
4945(g), such grant shall not be treated as a taxable expenditure even 
if it is a scholarship or a fellowship grant which is not excludable 
from income under section 117 or if it is a prize or award which is 
includible in income under section 74.
    (iii) Renewals. A renewal of a grant which satisfied the 
requirements of subdivision (ii) of this subparagraph shall not be 
treated as a grant to an individual which is subject to the requirements 
of this section, if:
    (a) The grantor has no information indicating that the original 
grant is being used for any purpose other than that for which it was 
made,
    (b) Any reports due at the time of the renewal decision pursuant to 
the terms of the original grant have been furnished, and
    (c) Any additional criteria and procedures for renewal are objective 
and nondiscriminatory.


For purposes of this section, an extension of the period over which a 
grant is to be paid shall not itself be regarded as a grant or a renewal 
of a grant.
    (4) Certain designated grants--(i) In general. A grant by a private 
foundation to another organization, which the grantee organization uses 
to make payments to an individual for purposes described in section 
4945(d)(3), shall not be regarded as a grant by the private

[[Page 176]]

foundation to the individual grantee if the foundation does not earmark 
the use of the grant for any named individual and there does not exist 
an agreement, oral or written, whereby such grantor foundation may cause 
the selection of the individual grantee by the grantee organization. For 
purposes of this subparagraph, a grant described herein shall not be 
regarded as a grant by the foundation to an individual grantee even 
though such foundation has reason to believe that certain individuals 
would derive benefits from such grant so long as the grantee 
organization exercises control, in fact, over the selection process and 
actually makes the selection completely independently of the private 
foundation.
    (ii) Certain grants to ``public charities''. A grant by a private 
foundation to an organization described in section 509(a) (1), (2), or 
(3), which the grantee organization uses to make payments to an 
individual for purposes described in section 4945(d)(3), shall not be 
regarded as a grant by the private foundation to the individual grantee 
(regardless of the application of subdivision (i) of this subparagraph) 
if the grant is made for a project which is to be undertaken under the 
supervision of the section 509(a) (1), (2), or (3) organization and such 
grantee organization controls the selection of the individual grantee. 
This subdivision shall apply regardless of whether the name of the 
individual grantee was first proposed by the private foundation, but 
only if there is an objective manifestation of the section 509(a), (1), 
(2), or (3) organization's control over the selection process, although 
the selection need not be made completely independently of the private 
foundation. For purposes of this subdivision, an organization shall be 
considered a section 509(a)(1) organization if it is treated as such 
under subparagraph (4) of Sec. 53.4945-5(a).
    (iii) Grants to governmental agencies. If a private foundation makes 
a grant to an organization described in section 170(c)(1) (regardless of 
whether it is described in section 501(c)(3)) and such grant is 
earmarked for use by an individual for purposes described in section 
4945(d)(3), such grant is not subject to the requirements of section 
4945(d)(3) and (g) and this section (regardless of the application of 
subdivision (i) of this subparagraph) if the section 170(c)(1) 
organization satisfies the Commissioner in advance that its grant-making 
program:
    (a) Is in furtherance of a purpose described in section 
170(c)(2)(B),
    (b) Requires that the individual grantee submit reports to it which 
would satisfy paragraph (c)(3) of this section, and
    (c) Requires that the organization investigate jeopardized grants in 
a manner substantially similar to that described in paragraph (c)(4) of 
this section.
    (iv) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. M, a university described in section 170(b)(1)(A)(ii), 
requests that P, a private foundation, grant it $100,000 to enable M to 
obtain the services of a particular scientist for a research project in 
a special field of biochemistry in which he has exceptional 
qualifications and competence. P, after determining that the project 
deserves support, makes the grant to M to enable it to obtain the 
services of this scientist. M is authorized to keep the funds even if it 
is unsuccessful in attempting to employ the scientist. Under these 
circumstances P will not be treated as having made a grant to the 
individual scientist for purposes of section 4945(d)(3) and (g), since 
the requirements of subdivision (i) of this subparagraph have been 
satisfied. Even if M were not authorized to keep the funds if it is 
unsuccessful in attempting to employ the scientist, P would not be 
treated as having made a grant to the individual scientist for purposes 
of section 4945(d)(3) and (g), since it is clear from the facts and 
circumstances that the selection of the particular scientist was made by 
M and thus the requirements of subdivision (ii) of this subparagraph 
would have been satisfied.
    Example 2. Assume the same facts as Example (1), except that there 
are a number of scientists who are qualified to administer the research 
project, P suggests the name of the particular scientist to be employed 
by M, and M is not authorized to keep the funds if it is unsuccessful in 
attempting to employ the particular scientist. For purposes of section 
4945(d)(3) and (g), P will be treated as having made a grant to the 
individual scientist whose name it suggested, since it is clear from the 
facts and circumstances that selection of the particular scientist was 
made by P.
    Example 3. X, a private foundation, is aware of the exceptional 
research facilities at Y University, an organization described in

[[Page 177]]

section 170(b)(1)(A)(ii). Officials of X approach officials of Y with an 
offer to give Y a grant of $100,000 if Y will engage an adequately 
qualified physicist to conduct a specific research project. Y's 
officials accept this proposal, and it is agreed that Y will administer 
the funds. After examining the qualifications of several research 
physicists, the officials of Y agree that A, whose name was first 
suggested by officials of X and who first suggested the specific 
research project to X, is uniquely qualified to conduct the project. X's 
grant letter provides that X has the right to renegotiate the terms of 
the grant if there is a substantial deviation from such terms, such as 
breakdown of Y's research facilities or termination of the conduct of 
the project by an adequately qualified physicist. Under these 
circumstances, X will not be treated as having made a grant to A for 
purposes of section 4945(d)(3) and (g), since the requirements of 
subdivision (ii) of this subparagraph have been satisfied.
    Example 4. Professor A, a scholar employed by University Y, an 
organization described in section 170(b)(1)(A)(ii), approaches 
Foundation X to determine the availability of grant funds for a 
particular research project supervised or conducted by Professor A 
relevant to the program interests of Foundation X. After learning that 
Foundation X would be willing to consider the project if University Y 
were to submit the project to X, Professor A submits his proposal to the 
appropriate administrator of University Y. After making a determination 
that it should assume responsibility for the project, that Professor A 
is qualified to conduct the project, and that his participation would be 
consistent with his other faculty duties, University Y formally adopts 
the grant proposal and submits it to Foundation X. The grant is made to 
University Y which, under the terms of the grant, is responsible for the 
expenditure of the grant funds and the grant project. In such a case, 
and even if Foundation X retains the right to renegotiate the terms of 
the grant if the project ceases to be conducted by Professor A, the 
grant shall not be regarded as a grant by Foundation X to Professor A 
since University Y has retained control over the selection process 
within the meaning of subdivision (ii) of this subparagraph.

    (5) Earmarked grants to individuals. A grant by a private foundation 
to an individual, which meets the requirements of section 4945(d)(3) and 
(g), is a taxable expenditure by such foundation under section 4945(d) 
only if:
    (i) The grant is earmarked to be used for any activity described in 
section 4945(d) (1), (2), or (5), or is earmarked to be used in a manner 
which would violate section 4945(d) (3) or (4),
    (ii) There is an agreement, oral or written, whereby such grantor 
foundation may cause the grantee to engage in any such prohibited 
activity and such grant is in fact used in a manner which violates 
section 4945(d), or
    (iii) The grant is made for a purpose other than a purpose described 
in section 170(c)(2)(B).

For purposes of this subparagraph, a grant by a private foundation is 
earmarked if such grant is given pursuant to an agreement, oral or 
written, that the grant will be used for specific purposes.
    (b) Selection of grantees on ``an objective and nondiscriminatory 
basis''--(1) In general. For purposes of this section, in order for a 
foundation to establish that its grants to individuals are made on an 
objective and nondiscriminatory basis, the grants must be awarded in 
accordance with a program which, if it were a substantial part of the 
foundation's activities, would be consistent with:
    (i) The existence of the foundation's exempt status under section 
501(c)(3);
    (ii) The allowance of deductions to individuals under section 170 
for contributions to the granting foundation; and
    (iii) The requirements of subparagraphs (2), (3), and (4) of this 
paragraph.
    (2) Candidates for grants. Ordinarily, selection of grantees on an 
objective and nondiscriminatory basis requires that the group from which 
grantees are selected be chosen on the basis of criteria reasonably 
related to the purposes of the grant. Furthermore, the group must be 
sufficiently broad so that the giving of grants to members of such group 
would be considered to fulfill a purpose described in section 
170(c)(2)(B). Thus, ordinarily the group must be sufficiently large to 
constitute a charitable class. However, selection from a group is not 
necessary where taking into account the purposes of the grant, one or 
several persons are selected because they are exceptionally qualified to 
carry out these purposes or it is otherwise evident that the selection 
is particularly calculated to effectuate the charitable purpose of the 
grant rather than to benefit particular persons or a particular class of 
persons.

[[Page 178]]

Therefore, consistent with the requirements of this subparagraph, the 
foundation may impose reasonable restrictions on the group of potential 
grantees. For example, selection of a qualified research scientist to 
work on a particular project does not violate the requirements of 
section 4945(d)(3) merely because the foundation selects him from a 
group of three scientists who are experts in that field.
    (3) Selection from within group of potential grantees. The criteria 
used in selecting grant recipients from the potential grantees should be 
related to the purpose of the grant. Thus, for example, proper criteria 
for selecting scholarship recipients might include (but are not limited 
to) the following: Prior academic performance; performance on tests 
designed to measure ability and aptitude for college work; 
recommendations from instructors; financial need; and the conclusions 
which the selection committee might draw from a personal interview as to 
the individual's motivation, character, ability, and potential.
    (4) Persons making selections. The person or group of persons who 
select recipients of grants should not be in a position to derive a 
private benefit, directly or indirectly, if certain potential grantees 
are selected over others.
    (5) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. X company employs 100,000 people of whom 1,000 are 
classified by the company as executives. The company has organized the X 
company foundation which, as its sole activity, provides 100 4-year 
college scholarships per year for children of the company's employees. 
Children of all employees (other than disqualified persons with respect 
to the foundation) who have worked for the X company for at least 2 
years are eligible to apply for these scholarships. In previous years, 
the number of children eligible to apply for such scholarships has 
averaged 2,000 per year. Selection of scholarship recipients from among 
the applicants is made by three prominent educators, who have no 
connection (other than as members of the selection committee) with the 
company, the foundation or any of the employees of the company. The 
selections are made on the basis of the applicants' prior academic 
performance, performance on certain tests designed to measure ability 
and aptitude for college work, and financial need. No disproportionate 
number of scholarships has been granted to relatives of executives of X 
company. Under these circumstances, the operation of the scholarship 
program by the X company foundation: (1) Is consistent with the 
existence of the foundation's exempt status under section 501(c) (3) and 
with the allowance of deductions under section 170 for contributions to 
the foundation; (2) utilizes objective and nondiscriminatory criteria in 
selecting scholarship recipients from among the applicants; and (3) 
utilizes a selection committee which appears likely to make objective 
and nondiscriminatory selections of grant recipients.
    Example 2. Assume the same facts as Example (1), except that the 
foundation establishes a program to provide 20 college scholarships per 
year for members of a certain ethnic minority. All members of this 
minority group (other than disqualified persons with respect to the 
foundation) living in State Z are eligible to apply for these 
scholarships. It is estimated that at least 400 persons will be eligible 
to apply for these scholarships each year. Under these circumstances, 
the operation of this scholarship program by the foundation: (1) Is 
consistent with the existence of the foundation's exempt status under 
section 501(c)(3) and with the allowance of deductions under section 170 
for contributions to the foundation; (2) utilizes objective and 
nondiscriminatory criteria in selecting scholarship recipients from 
among the applicants; and (3) utilizes a selection committee which 
appears likely to make objective and nondiscriminatory selections of 
grant recipients.

    (c) Requirements of a proper procedure--(1) In general. Section 
4945(g) requires that grants to individuals must be made pursuant to a 
procedure approved in advance. To secure such approval, a private 
foundation must demonstrate to the satisfaction of the Commissioner 
that:
    (i) Its grant procedure includes an objective and nondiscriminatory 
selection process (as described in paragraph (b) of this section);
    (ii) Such procedure is reasonably calculated to result in 
performance by grantees of the activities that the grants are intended 
to finance; and
    (iii) The foundation plans to obtain reports to determine whether 
the grantees have performed the activities that the grants are intended 
to finance.

No single procedure or set of procedures is required. Procedures may 
vary depending upon such factors as the size

[[Page 179]]

of the foundation, the amount and purpose of the grants and whether one 
or more recipients are involved.
    (2) Supervision of scholarship and fellowship grants. Except as 
provided in subparagraph (5) of this paragraph, with respect to any 
scholarship or fellowship grants, a private foundation must make 
arrangements to receive a report of the grantee's courses taken (if any) 
and grades received (if any) in each academic period. Such a report must 
be verified by the educational institution attended by the grantee and 
must be obtained at least once a year. In cases of grantees whose study 
at an educational institution does not involve the taking of courses but 
only the preparation of research papers or projects, such as the writing 
of a doctoral thesis, the foundation must receive a brief report on the 
progress of the paper or project at least once a year. Such a report 
must be approved by the faculty member supervising the grantee or by 
another appropriate university official. Upon completion of a grantee's 
study at an educational institution, a final report must also be 
obtained.
    (3) Grants described in section 4945(g)(3). With respect to a grant 
made under section 4945(g)(3), the private foundation shall require 
reports on the use of the funds and the progress made by the grantee 
toward achieving the purposes for which the grant was made. Such reports 
must be made at least once a year. Upon completion of the undertaking 
for which the grant was made, a final report must be made describing the 
grantee's accomplishments with respect to the grant and accounting for 
the funds received under such grant.
    (4) Investigation of jeopardized grants. (i) Where the reports 
submitted under this paragraph or other information (including the 
failure to submit such reports) indicates that all or any part of a 
grant is not being used in furtherance of the purposes of such grant, 
the foundation is under a duty to investigate. While conducting its 
investigation, the foundation must withhold further payments to the 
extent possible until any delinquent reports required by this paragraph 
have been submitted and where required by subdivision (ii) or (iii) of 
this subparagraph.
    (ii) In cases in which the grantor foundation determines that any 
part of a grant has been used for improper purposes and the grantee has 
not previously diverted grant funds to any use not in furtherance of a 
purpose specified in the grant, the foundation will not be treated as 
having made a taxable expenditure solely because of the diversion so 
long as the foundation:
    (a) Is taking all reasonable and appropriate steps either to recover 
the grant funds or to insure the restoration of the diverted funds and 
the dedication (consistent with the requirements of (b) (1) and (2) of 
this subdivision) of other grant funds held by the grantee to the 
purposes being financed by the grant, and
    (b) Withholds any further payments to the grantee after the grantor 
becomes aware that a diversion may have taken place (hereinafter 
referred to as ``further payments'') until it has:
    (1) Received the grantee's assurances that future diversions will 
not occur, and
    (2) Required the grantee to take extraordinary precaution to prevent 
future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision but not the requirements of (b) of this subdivision, the 
amount of the taxable expenditure shall be the amount of such further 
payments.
    (iii) In cases where a grantee has previously diverted funds 
received from a grantor foundation, and the grantor foundation 
determines that any part of a grant has again been used for improper 
purposes, the foundation will not be treated as having made a taxable 
expenditure solely by reason of such diversion so long as the 
foundation:

[[Page 180]]

    (a) Is taking all reasonable and appropriate steps to recover the 
grant funds or to insure the restoration of the funds and the dedication 
(consistent with the requirements of (b) (2) and (3) of this 
subdivision) of other grant funds held by the grantee to the purposes 
being financed by the grant, and
    (b) Withholds further payments until:
    (1) Such funds are in fact so recovered or restored,
    (2) It has received the grantee's assurances that future diversions 
will not occur, and
    (3) It requires the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision, 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision, but fails to withhold further payments until the 
requirements of (b) of this subdivision are met, the amount of the 
taxable expenditure shall be the amount of such further payments.
    (iv) The phrase ``all reasonable and appropriate steps'' in 
subdivisions (ii) and (iii) of this subparagraph includes legal action 
where appropriate but need not include legal action if such action would 
in all probability not result in the satisfaction of execution on a 
judgment.
    (5) Supervision of certain scholarship and fellowship grants. 
Subparagraphs (2) and (4) of this paragraph shall be considered 
satisfied with respect to scholarship or fellowship grants under the 
following circumstances:
    (i) The scholarship or fellowship grants are described in section 
4945(g) (1);
    (ii) The grantor foundation pays the scholarship or fellowship 
grants to an educational institution described in section 151(e) (4); 
and
    (iii) Such educational institution agrees to use the grant funds to 
defray the recipient's expenses or to pay the funds (or a portion 
thereof) to the recipient only if the recipient is enrolled at such 
educational institution and his standing at such educational institution 
is consistent with the purposes and conditions of the grant.
    (6) Retention of records. A private foundation shall retain records 
pertaining to all grants to individuals for purposes described in 
section 4945(d) (3). Such records shall include:
    (i) All information the foundation secures to evaluate the 
qualification of potential grantees;
    (ii) Identification of grantees (including any relationship of any 
grantee to the foundation sufficient to make such grantee a disqualified 
person of the private foundation within the meaning of section 4946(a) 
(1));
    (iii) Specification of the amount and purpose of each grant; and
    (iv) The follow-up information which the foundation obtains in 
complying with subparagraphs (2), (3), and (4) of this paragraph.
    (7) Example. The provisions of paragraphs (b) and (c) of this 
section may be illustrated by the following example:

    Example. The X foundation grants 10 scholarships each year to 
graduates of high schools in its area to permit the recipients to attend 
college. It makes the availability of its scholarships known by oral or 
written communications each year to the principals of three major high 
schools in the area. The foundation obtains information from each high 
school on the academic qualifications, background, and financial need of 
applicants. It requires that each applicant be recommended by two of his 
teachers or by the principal of his high school. All application forms 
are reviewed by the foundation officer responsible for making the awards 
and scholarships are granted on the basis of the academic qualifications 
and financial need of the grantees. The foundation obtains annual 
reports on the academic performance of the scholarship recipient from 
the college or university which he attends. It maintains a file on each 
scholarship awarded, including the original application, 
recommendations, a record of the action taken on the application, and 
the reports on the recipient from the institution which he attends. The 
described procedures of the X foundation for the making of grants to 
individuals qualify for Internal Revenue Service approval under

[[Page 181]]

section 4945(g). Furthermore, if the X foundation's scholarship program 
meets the requirements of subparagraph (5) of this paragraph, X 
foundation will not have to obtain reports on the academic performance 
of the scholarship recipients.

    (d) Submission of grant procedure--(1) Contents of request for 
approval of grant procedures. A request for advance approval of a 
foundation's grant procedures must fully describe the foundation's 
procedures for awarding grants and for ascertaining that such grants are 
used for the proper purposes. The approval procedure does not 
contemplate specific approval of particular grant programs but instead 
one-time approval of a system of standards, procedures, and follow-up 
designed to result in grants which meet the requirements of section 
4945(g). Thus, such approval shall apply to a subsequent grant program 
as long as the procedures under which it is conducted do not differ 
materially from those described in the request to the Commissioner. The 
request must contain the following items:
    (i) A statement describing the selection process. Such statement 
shall be sufficiently detailed for the Commissioner to determine whether 
the grants are made on an objective and nondiscriminatory basis under 
paragraph (b) of this section.
    (ii) A description of the terms and conditions under which the 
foundation ordinarily makes such grants, which is sufficient to enable 
the Commissioner to determine whether the grants awarded under such 
procedures would meet the requirements of paragraph (1), (2), or (3) of 
section 4945(g).
    (iii) A detailed description of the private foundation's procedure 
for exercising supervision over grants, as described in paragraph (c) 
(2) and (3) of this section.
    (iv) A description of the foundation's procedures for review of 
grantee reports, for investigation where diversion of grant funds from 
their proper purposes is indicated, and for recovery of diverted grant 
funds, as described in paragraph (c) (4) of this section.
    (2) Place of submission. Request for approval of grant procedures 
shall be submitted to the District Director.
    (3) Internal Revenue Service action on request for approval of grant 
procedures. The 45th day after a request for approval of grant 
procedures has been properly submitted to the Internal Revenue Service, 
the organization has not been notified that such procedures are not 
acceptable, such procedures shall be considered as approved from the 
date of submission until receipt of actual notice from the Internal 
Revenue Service that such procedures do not meet the requirements of 
this section. If a grant to an individual for a purpose described in 
section 4945(d) (3) is made after notification to the organization by 
the Internal Revenue Service that the procedures under which the grant 
is made are not acceptable, such grant is a taxable expenditure under 
this section.
    (e) Effective dates--(1) In general. This section shall apply to all 
grants to individuals for travel, study, or other similar purposes which 
are made by private foundations more than 90 days after October 30, 
1972.
    (2) Transitional rules--(i) Grants committed prior to January 1, 
1970. Section 4945(d) (3) and (g) and this section shall not apply to a 
grant for section 170(c) (2) (B) purposes made on or after January 1, 
1970, if the grant was made pursuant to a commitment entered into prior 
to such date, but only if such commitment was made in accordance with 
the foundation's usual practices and is reasonable in amount in light of 
the purposes of the grant. For purposes of this subdivision, a 
commitment will be considered entered into prior to January 1, 1970, if 
prior to such date, the amount and nature of the payments to be made and 
the name of the payee were entered on the records of the payor, or were 
otherwise adequately evidenced, or the notice of the payment to be 
received was communicated to the payee in writing.
    (ii) Grants awarded on or after January 1, 1970. In the case of a 
grant awarded on or after January 1, 1970, but prior to the expiration 
of 90 days after October 30, 1972, and paid within 48 months after the 
award of such grant, the requirements of section 4945(g) that an 
individual grant be awarded on an objective and nondiscriminatory basis 
pursuant to a procedure approved in

[[Page 182]]

advance by the Commissioner will be deemed satisfied if the grantor 
utilizes any procedure in good faith in awarding a grant to an 
individual which, in fact, is reasonably calculated to provide 
objectivity and nondiscrimination in the awarding of such grant and to 
result in a grant which complies with the conditions of section 4945(g) 
(1), (2), or (3).



Sec. 53.4945-5  Grants to organizations.

    (a) Grants to nonpublic organizations--(1) In general. Under section 
4945(d)(4) the term ``taxable expenditure'' includes any amount paid or 
incurred by a private foundation as a grant to an organization (other 
than an organization described in section 509(a) (1), (2) or (3)), 
unless the private foundation exercises expenditure responsibility with 
respect to such grant in accordance with section 4945(h). However, the 
granting foundation does not have to exercise expenditure responsibility 
with respect to amounts granted to organizations described in section 
4945(f).
    (2) ``Grants'' described. For a description of the term ``grants'', 
see Sec. 53.4945-4(a)(2).
    (3) Section 509(a) (1), (2), and (3) organizations. See section 
508(b) and the regulations thereunder for rules relating to when a 
grantor may rely on a potential grantee's characterization of its status 
as set forth in the notice described in section 508(b).
    (4) Certain ``public'' organizations. For purposes of this section, 
an organization will be treated as a section 509(a)(1) organization if:
    (i) It qualifies as such under paragraph (a) of Sec. 1.509(a)-2 of 
this chapter;
    (ii) It is an organization described in section 170(c)(1) or 
511(a)(2)(B), even if it is not described in section 501(c)(3); or
    (iii) It is a foreign government, or any agency or instrumentality 
thereof, or an international organization designated as such by 
Executive order under 22 U.S.C. 288, even if it is not described in 
section 501(c)(3).

However, any grant to an organization referred to in this subparagraph 
must be made exclusively for charitable purposes as described in section 
170(c)(2)(B).
    (5) Certain foreign organizations. If a private foundation makes a 
grant to a foreign organization which does not have a ruling or 
determination letter that it is an organization described in section 
509(a)(1), (2), or (3), such grant will not be treated as a grant made 
to an organization other than an organization described in section 
509(a)(1), (2), or (3) if the grantor private foundation has made a good 
faith determination that the grantee organization is an organization 
described in section 509(a)(1), (2), or (3). Such a ``good faith 
determination'' ordinarily will be considered as made where the 
determination is based on an affidavit of the grantee organization or an 
opinion of counsel (of the grantor or the grantee) that the grantee is 
an organization described in section 509(a)(1), (2), or (3). Such an 
affidavit or opinion must set forth sufficient facts concerning the 
operations and support of the grantee for the Internal Revenue Service 
to determine that the grantee would be likely to qualify as an 
organization described in section 509(a) (1), (2), or (3). See 
paragraphs (b)(5) and (b)(6) of this section for other special rules 
relating to foreign organizations.
    (6) Certain earmarked grants--(i) In general. 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.

[[Page 183]]

    (ii) To governmental agencies. If a private foundation makes a grant 
to an organization described in section 170(c)(1) and such grant is 
earmarked for use by another organization, the granting foundation need 
not exercise expenditure responsibility with respect to such grant if 
the section 170(c)(1) organization satisfies the Commissioner in advance 
that:
    (a) Its grant-making program is in furtherance of a purpose 
described in section 170(c)(2)(B), and
    (b) The section 170(c)(1) organization exercises ``expenditure 
responsibility'' in a manner that would satisfy this section if it 
applied to such section 170(c)(1) organization.


However, with respect to such grant, the granting foundation must make 
the reports required by section 4945(h)(3) and paragraph (d) of this 
section, unless such grant is earmarked for use by an organization 
described in section 509(a) (1), (2), or (3).
    (b) Expenditure responsibility--(1) In general. A private foundation 
is not an insurer of the activity of the organization to which it makes 
a grant. Thus, satisfaction of the requirements of sections 4945(d)(4) 
and (h) and of subparagraph (3) or (4) of this paragraph, will 
ordinarily mean that the grantor foundation will not have violated 
section 4945(d) (1) or (2). A private foundation will be considered to 
be exercising ``expenditure responsibility'' under section 4945(h) as 
long as it exerts all reasonable efforts and establishes adequate 
procedures:
    (i) To see that the grant is spent solely for the purpose for which 
made,
    (ii) To obtain full and complete reports from the grantee on how the 
funds are spent, and
    (iii) To make full and detailed reports with respect to such 
expenditures to the Commissioner.

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. For rules relating to expenditure responsibility with respect 
to transfers of assets described in section 507(b)(2), see section 
507(b)(2) and the regulations thereunder.
    (2) Pre-grant inquiry--(i) 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. The inquiry should concern itself with matters 
such as: (a) The identity, prior history and experience (if any) of the 
grantee organization and its managers; and (b) any knowledge which the 
private foundation has (based on prior experience or otherwise) of, or 
other information which is readily available concerning, the management, 
activities, and practices of the grantee organization. The scope of the 
inquiry might be expected to vary from case to case depending upon the 
size and purpose of the grant, the period over which it is to be paid, 
and the prior experience which the grantor has had with respect to the 
capacity of the grantee to use the grant for the proper purposes. For 
example, if the grantee has made proper use of all prior grants to it by 
the grantor and filed the required reports substantiating such use, no 
further pregrant inquiry will ordinarily be necessary. Similarly, in the 
case of an organization, such as a trust described in section 
4947(a)(2), which is required by the terms of its governing instrument 
to make payments to a specified organization exempt from taxation under 
section 501(a), a less extensive pregrant inquiry is required than in 
the case of a private foundation possessing discretion with respect to 
the distribution of funds.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. Officials of M, a newly established organization which is 
described in section 501(c)(4), request a grant from X foundation to be 
used for a proposed program to combat drug abuse by establishing 
neighborhood clinics in certain ghetto areas of a city. Before making a 
grant to M, X makes an inquiry concerning the identity, prior history 
and experience of the officials of M. X obtains information pertaining 
to the officials

[[Page 184]]

of M from references supplied by these officials. Since one of the 
references indicated that A, an official of M, has an arrest record, 
police records are also checked and A's probation officer is 
interviewed.
    The inquiry also shows M has no previous history of administering 
grants and that the officials of M have had no experience in 
administering programs of this nature. However, in the opinion of X's 
managers, M's officials (including A who appears to be fully 
rehabilitated after having been convicted of a narcotics violation 
several years ago) are well qualified to conduct this program since they 
are members of the communities in which the clinics are to be 
established and are more likely to be trusted by drug users in these 
communities than are outsiders. Under these circumstances X has complied 
with the requirements of this subparagraph and a grant to M for its 
proposed program will not be treated as a taxable expenditure solely 
because of the operation of this subparagraph.
    Example 2. Foundation Y wishes to make a grant to foundation R for 
use in R's scholarship program. Y has made similar grants to R annually 
for the last several years and knows that R's managers have observed the 
terms of the previous grants and have made all requested reports with 
respect to such grants. No changes in R's management have occurred 
during the past several years. Under these circumstances, Y has enough 
information to have such assurance as a reasonable man would require 
that the grant to R will be used for proper purposes. Consequently, Y is 
under no obligation to make any further pregrant inquiry pursuant to 
this subparagraph.
    Example 3. S foundation requests a grant from Z foundation for use 
in S's program of providing medical research fellowships. S has been 
engaged in this program for several years and has received large numbers 
of grants from other foundations. Z's managers know that the reputations 
of S and of S's officials are good. Z's managers also have been advised 
by managers of W foundation that W had recently made a grant to S and 
that W's managers were satisfied that such grant has been used for the 
purposes for which it was made. Under these circumstances Z has enough 
information to have such assurance as a reasonable man would require 
that the grant to S will be used for proper purposes. Consequently, Z is 
under no obligation to make any further pregrant inquiry pursuant to 
this subparagraph.

    (3) Terms of grants. 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. Such 
purposes may include contributing for capital endowment, for the 
purchase of capital equipment, or for general support provided that 
neither the grants nor the income therefrom may be used for purposes 
other than those described in section 170(c)(2)(B).
    (4) Terms of program-related investments. In order to meet the 
expenditure responsibility requirements of section 4945(h), with regard 
to the making of a program-related investment (as defined in section 
4944 and the regulations thereunder), a private foundation must require 
that each such investment with respect to which expenditure 
responsibility must be exercised under section 4945(d)(4) and (h) and 
this section be made subject to a written commitment

[[Page 185]]

signed by an appropriate officer, director, or trustee of the recipient 
organization. Such commitment must specify the purpose of the investment 
and must include an agreement by the organization:
    (i) To use all the funds received from the private foundation (as 
determined under paragraph (c)(3) of this section) only for the purposes 
of the investment and to repay any portion not used for such purposes, 
provided that, with respect to equity investments, such repayment shall 
be made only to the extent permitted by applicable law concerning 
distributions to holders of equity interests,
    (ii) At least once a year during the existence of the program-
related investment, to submit full and complete financial reports of the 
type ordinarily required by commercial investors under similar 
circumstances and a statement that it has complied with the terms of the 
investment,
    (iii) To maintain books and records adequate to provide information 
ordinarily required by commercial investors under similar circumstances 
and to make such books and records available to the private foundation 
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, and voter registration drive (within 
the meaning of section 4945(d)(2)), or
    (c) With respect to any recipient which is a private foundation (as 
defined in section 509(a)), to make any grant which does not comply with 
the requirements of section 4945 (d) (3) or (4).
    (5) Certain grants to foreign organizations. With respect to a grant 
to a foreign organization (other than an organization described in 
section 509(a) (1), (2), or (3) or treated as so described pursuant to 
paragraph (a)(4) or (a)(5) of this section), subparagraph (3)(iv) or 
(4)(iv) of this paragraph shall be deemed satisfied if the agreement 
referred to in subparagraph (3) or (4) of this paragraph imposes 
restrictions on the use of the grant substantially equivalent to the 
limitations imposed on a domestic private foundation under section 
4945(d). Such restrictions may be phrased in appropriate terms under 
foreign law or custom and ordinarily will be considered sufficient if an 
affidavit or opinion of counsel (of the grantor or grantee) is obtained 
stating that, under foreign law or custom, the agreement imposes 
restrictions on the use of the grant substantially equivalent to the 
restrictions imposed on a domestic private foundation under subparagraph 
(3) or (4) of this paragraph.
    (6) Special rules for grants by foreign private foundations. With 
respect to activities in jurisdictions other than those described in 
section 170(c)(2)(A), the failure of a foreign private foundation which 
is described in section 4948(b) to comply with subparagraph (3) or (4) 
of this paragraph with respect to a grant to an organization shall not 
constitute an act or failure to act which is a prohibited transaction 
(within the meaning of section 4948(c)(2)).
    (7) Expenditure responsibility with respect to certain transfers of 
assets described in section 507--(i) Transfers of assets described in 
section 507(b)(2). For rules relating to the extent to which the 
expenditure responsibility rules contained in section 4945 (d)(4) and 
(h) and this section apply to transfers of assets described in section 
507(b)(2), see Sec. Sec. 1.507-3(a)(7), 1.507-3 (a)(8)(ii)(f), and 
1.507-3(a)(9) of this chapter.
    (ii) Certain other transfers of assets. For rules relating to the 
extent to which the expenditure responsibility rules contained in 
section 4945 (d)(4) and (h) and this section apply to certain other 
transfers of assets described in Sec. 1.507-3(b) of this chapter, see 
Sec. 1.507-3(b) of this chapter.
    (8) Restrictions on grants (other than program-related investments) 
to organizations not described in section 501(c)(3). For other 
restrictions on certain grants (other than program-related investments) 
to organizations which are not described in section 501(c)(3), see Sec. 
53.4945-6(c).
    (c) Reports from grantees--(1) In general. In the case of grants 
described in section 4945(d)(4), except as provided in subparagraph (2) 
of this paragraph, the

[[Page 186]]

granting private foundation shall require reports on the use of the 
funds, compliance with the terms of the grant, and the progress made by 
the grantee toward achieving the purposes for which the grant was made. 
The grantee shall make such reports as of the end of its annual 
accounting period within which the grant or any portion thereof is 
received and all such subsequent periods until the grant funds are 
expended in full or the period of the grantee for which such reports 
shall be furnished to the grantor within a reasonable period of time 
after the close of the annual accounting period of the grantee for which 
such reports are made. Within a reasonable period of time after the 
close of its annual accounting period during which the use of the grant 
funds is completed, the grantee must make a final report with respect to 
all expenditures made from such funds (including salaries, travel, and 
supplies), and indicating the progress made toward the goals of the 
grant. The grantor need not conduct any independent verification of such 
reports unless it has reason to doubt their accuracy or reliability.
    (2) Capital endowment grants to exempt private foundations. If a 
private foundation makes a grant described in section 4945(d)(4) to a 
private foundation which is exempt from taxation under section 501(a) 
for endowment, for the purchase of capital equipment, or for other 
capital purposes, the grantor foundation shall require reports from the 
grantee on the use of the principal and the income (if any) from the 
grant funds. The grantee shall make such reports annually for its 
taxable year in which the grant was made and the immediately succeeding 
2 taxable years. Only if it is reasonably apparent to the grantor that, 
before the end of such second succeeding taxable year, neither the 
principal, the income from the grant funds, nor the equipment purchased 
with the grant funds has been used for any purpose which would result in 
liability for tax under section 4945(d), the grantor may then allow such 
reports to be discontinued.
    (3) Grantees' accounting and recordkeeping procedures. (i) A private 
foundation grantee exempt from taxation under section 501(a) (or the 
recipient of a program-related investment) need not segregate grant 
funds physically nor separately account for such funds on its books 
unless the grantor requires such treatment of the grant funds. If such a 
grantee neither physically segregates grant funds nor establishes 
separate accounts on its books, grants received within a given taxable 
year beginning after December 31, 1969, shall be deemed, for purposes of 
section 4945, to be expended before grants received in a succeeding 
taxable year. In such case expenditures of grants received within any 
such taxable year shall be prorated among all such grants.

In accounting for grant expenditures, private foundations may make the 
necessary computations on a cumulative annual basis (or, where 
appropriate, as of the date for which the computations are made). The 
rules set forth in the preceding three sentences shall apply to the 
extent they are consistent with the available records of the grantee and 
with the grantee's treatment of qualifying distributions under section 
4942(h) and the regulations thereunder. The records of expenditures, as 
well as copies of the reports submitted to the grantor, must be kept for 
at least 4 years after completion of the use of the grant funds.
    (ii) For rules relating to accounting and recordkeeping requirements 
for grantees other than those described in subdivision (i) of this 
subparagraph, see Sec. Sec. 53.4945-5(b)(8) and 53.4945-6(c).
    (4) Reliance on information supplied by grantee. A private 
foundation exercising expenditure responsibility with respect to its 
grants may rely on adequate records or other sufficient evidence 
supplied by the grantee organization (such as a statement by an 
appropriate officer, director or trustee of such grantee organization) 
showing, to the extent applicable, the information which the grantor 
must report to the Internal Revenue Service in accordance with paragraph 
(d)(2) of this section.
    (d) Reporting to Internal Revenue Service by grantor--(1) In 
general. To satisfy the reportmaking requirements of section 4945(h)(3), 
a granting foundation must provide the required information

[[Page 187]]

on its annual information return, required to be filed by section 6033, 
for each taxable year with respect to each grant made during the taxable 
year which is subject to the expenditure responsibility requirements of 
section 4945(h). Such information must also be provided on such return 
with respect to each grant subject to such requirements upon which any 
amount or any report is outstanding at any time during the taxable year. 
However, with respect to any grant made for endowment or other capital 
purposes, the grantor must provide the required information only for any 
taxable year for which the grantor must require a report from the 
grantee under paragraph (c)(2) of this section. The requirements of this 
subparagraph with respect to any grant may be satisfied by submission 
with the foundation's information return of a report received from the 
grantee, if the information required by subparagraph (2) of this 
paragraph is contained in such report.
    (2) Contents of report. The report required by this paragraph shall 
include the following information:
    (i) The name and address of the grantee.
    (ii) The date and amount of the grant.
    (iii) The purpose of the grant.
    (iv) The amounts expended by the grantee (based upon the most recent 
report received from the grantee).
    (v) Whether the grantee has diverted any portion of the funds (or 
the income therefrom in the case of an endowment grant) from the purpose 
of the grant (to the knowledge of the grantor).
    (vi) The dates of any reports received from the grantee.
    (vii) The date and results of any verification of the grantee's 
reports undertaken pursuant to and to the extent required under 
paragraph (c)(1) of this section by the grantor or by others at the 
direction of the grantor.
    (3) Recordkeeping requirements. In addition to the information 
included on the information return, a granting foundation shall make 
available to the Internal Revenue Service at the foundation's principal 
office each of the following items:
    (i) A copy of the agreement covering each ``expenditure 
responsibility'' grant made during the taxable year.
    (ii) A copy of each report received during the taxable year from 
each grantee on any ``expenditure responsibility'' grant, and
    (iii) A copy of each report made by the grantor's personnel or 
independent auditors of any audits or other investigations made during 
the taxable year with respect to any ``expenditure responsibility'' 
grant.
    (4) Reports received after the close of grantor's accounting year. 
Data contained in reports required by this paragraph, which reports are 
received by a private foundation after the close of its accounting year 
but before the due date of its information return for that year, need 
not be reported on such return, but may be reported on the grantor's 
information return for the year in which such reports are received from 
the grantee.
    (e) Violations of expenditure responsibility requirements--(1) 
Diversions by grantee. (i) Any diversion of grant funds (including the 
income therefrom in the case of an endowment grant) by the grantee to 
any use not in furtherance of a purpose specified in the grant may 
result in the diverted portion of such grant being treated as a taxable 
expenditure of the grantor under section 4945(d)(4). However, for 
purposes of this section, the fact that a grantee does not use any 
portion of the grant funds as indicated in the original budget 
projection shall not be treated as a diversion if the use to which the 
funds are committed is consistent with the purpose of the grant as 
stated in the grant agreement and does not result in a violation of the 
terms of such agreement required to be included by paragraph (b)(3) or 
(b)(4) of this section.
    (ii) In any event, a grantor will not be treated as having made a 
taxable expenditure under section 4945(d)(4) solely by reason of a 
diversion by the grantee, if the grantor has complied with subdivision 
(iii) (a) and (b) or (iv) (a) and (b) of this subparagraph, whichever is 
applicable.
    (iii) In cases in which the grantor foundation determines that any 
part of

[[Page 188]]

a grant has been used for improper purposes and the grantee has not 
previously diverted grant funds, the foundation will not be treated as 
having made a taxable expenditure solely by reason of the diversion so 
long as the foundation:
    (a) Is taking all reasonable and appropriate steps either to recover 
the grant funds or to insure the restoration of the diverted funds and 
the dedication (consistent with the requirements of (b) (1) and (2) of 
this subdivision) of the other grant funds held by the grantee to the 
purposes being financed by the grant, and
    (b) Withholds any further payments to the grantee after the grantor 
becomes aware that a diversion may have taken place (hereinafter 
referred to as ``further payments'') until it has:
    (1) Received the grantee's assurances that future diversions will 
not occur, and
    (2) Required the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision 
the amount of the taxable expenditure shall be the amount of the 
diversion (for example, the income diverted in the case of an endowment 
grant, or the rental value of capital equipment for the period of time 
for which diverted) plus the amount of any further payments to the same 
grantee. However, if the foundation complies with the requirements of 
(a) of this subdivision but not the requirements of (b) of this 
subdivision, the amount of the taxable expenditure shall be the amount 
of such further payments.
    (iv) In cases where a grantee has previously diverted funds received 
from a grantor foundation, and the grantor foundation determines that 
any part of a grant has again been used for improper purposes, the 
foundation will not be treated as having made a taxable expenditure 
solely by reason of such diversion so long as the foundation:
    (a) Is taking all reasonable and appropriate steps to recover the 
grant funds or to insure the restoration of the diverted funds and the 
dedication (consistent with the requirements of (b) (2) and (3) of this 
subdivision) of other grant funds held by the grantee to the purposes 
being financed by the grant, except that if, in fact, some or all of the 
diverted funds are not so restored or recovered, then the foundation 
must take all reasonable and appropriate steps to recover all of the 
grant funds, and
    (b) Withholds further payments until:
    (1) Such funds are in fact so recovered or restored,
    (2) It has received the grantee's assurances that future diversions 
will not occur, and
    (3) It requires the grantee to take extraordinary precautions to 
prevent future diversions from occurring.


If a foundation is treated as having made a taxable expenditure under 
this subparagraph in a case to which this subdivision applies, then 
unless the foundation meets the requirements of (a) of this subdivision, 
the amount of the taxable expenditure shall be the amount of the 
diversion plus the amount of any further payments to the same grantee. 
However, if the foundation complies with the requirements of (a) of this 
subdivision, but fails to withhold further payments until the 
requirements of (b) of this subdivision are met, the amount of the 
taxable expenditure shall be the amount of such further payments.
    (v) The phrase ``all reasonable and appropriate steps'' (as used in 
subdivisions (iii) and (iv) of this subparagraph) includes legal action 
where appropriate but need not include legal action if such action would 
in all probability not result in the satisfaction of execution on a 
judgment.
    (2) Grantee's failure to make reports. A failure by the grantee to 
make the reports required by paragraph (c) of this section (or the 
making of inadequate reports) shall result in the grant's being treated 
as a taxable expenditure by the grantor unless the grantor:
    (i) Has made the grant in accordance with paragraph (b) of this 
section,
    (ii) Has complied with the reporting requirements contained in 
paragraph (d) of this section,

[[Page 189]]

    (iii) Makes a reasonable effort to obtain the required report, and
    (iv) Withholds all future payments on this grant and on any other 
grant to the same grantee until such report is furnished.
    (3) Violations by the grantor. In addition to the situations 
described in subparagraphs (1) and (2) of this paragraph, a grant which 
is subject to the expenditure responsibility requirements of section 
4945(h) will be considered a taxable expenditure of the granting 
foundation if the grantor:
    (i) Fails to make a pregrant inquiry as described in paragraph 
(b)(2) of this section,
    (ii) Fails to make the grant in accordance with a procedure 
consistent with the requirements of paragraph (b) (3) or (4) of this 
section, or
    (iii) Fails to report to the Internal Revenue Service as provided in 
paragraph (d) of this section.
    (f) Effective dates--(1) In general. This section shall apply to all 
grants which are subject to the expenditure responsibility requirements 
of section 4945(d)(4) and (h) and which are made by private foundations 
more than 90 days after October 30, 1972.
    (2) Transitional rules--(i) Certain grants awarded prior to May 27, 
1969. Section 4945(d)(4) and (h) and this section shall not apply to a 
grant to a private foundation which is not controlled, directly or 
indirectly, by the grantor foundation or one or more disqualified 
persons (as defined in section 4946) with respect to the grantor 
foundation, provided that such grant:
    (a) Is made pursuant to a written commitment which was binding on 
May 26, 1969, and at all times thereafter,
    (b) Is made for one or more of the purposes described in section 
170(c)(2)(B), and
    (c) Is to be paid out to such grantee foundation on or before 
December 31, 1974.
    (ii) Grants or expenditures committed prior to January 1, 1970. 
Except as provided in paragraph (e)(2)(i) of Sec. 53.4945-4, section 
4945 shall not apply to a grant or an expenditure for section 
170(c)(2)(B) purposes made on or after January 1, 1970, if the grant or 
expenditure was made pursuant to a commitment entered into prior to such 
date, but only if (in the case of a grant or an expenditure other than 
an unlimited general-purpose grant to an organization) such commitment 
is reasonable in amount in light of the purposes of the grant. For 
purposes of this subdivision, a commitment will be considered entered 
into prior to January 1, 1970, if prior to such date, the amount and 
nature of the payments to be made and the name of the payee were entered 
on the records of the payor, or were otherwise adequately evidenced, or 
the notice of the payment to be received was communicated to the payee 
in writing.
    (iii) Grants awarded on or after January 1, 1970. Paragraphs (b), 
(c), and (d) of this section shall not apply to grants awarded on or 
after January 1, 1970, but prior to the expiration of 90 days after 
October 30, 1972, if the grantor has made reasonable efforts, and has 
established adequate procedures such as a prudent man would adopt in 
managing his own property, to see that the grant is spent solely for the 
purpose for which made, to obtain full and complete reports from the 
grantee on how the funds are spent, and to make full and detailed 
reports with respect to such grant to the Commissioner. With respect to 
any return filed with the Internal Revenue Service before the expiration 
of 90 days after October 30, 1972, the grantor may treat reports which 
satisfy the requirements of the statement to be attached to Form 4720 
for the year 1970 under ``Specific Instructions--Question B'' (items (1) 
through (5)) as satisfying the grantor reporting requirements with 
respect to ``expenditure responsibility'' grants. In the case of a 
private foundation required to file an annual return for a taxable year 
ending after January 1, 1970, and before December 31, 1970, the 
reporting requirements imposed by section 4945(h)(3) for such period 
shall be regarded as satisfied if such reports are made on the annual 
return for its first taxable year beginning after December 31, 1969.

[T.D. 7215, 37 FR 23161, Oct. 31, 1972; 37 FR 23918, Nov. 10, 1972, as 
amended by T.D. 7233, 37 FR 28162, Dec. 21, 1972; T.D. 7290, 38 FR 
31834, Nov. 19, 1973]

[[Page 190]]



Sec. 53.4945-6  Expenditures for noncharitable purposes.

    (a) In general. Under section 4945(d)(5) the term ``taxable 
expenditure'' includes any amount paid or incurred by a private 
foundation for any purpose other than one specified in section 
170(c)(2)(B). Thus, ordinarily only an expenditure for an activity 
which, if it were a substantial part of the organization's total 
activities, would cause loss of tax exemption is a taxable expenditure 
under section 4945(d)(5). For purposes of this section and Sec. Sec. 
53.4945-1 through 53.4945-5, the term ``purposes described in section 
170(c)(2)(B)'' shall be treated as including purposes described in 
section 170(c)(2)(B) whether or not carried out by an organization 
described in section 170(c).
    (b) Particular expenditures. (1) The following types of expenditures 
ordinarily will not be treated as taxable expenditures under section 
4945(d)(5):
    (i) Expenditures to acquire investments entered into for the purpose 
of obtaining income or funds to be used in furtherance of purposes 
described in section 170(c)(2)(B),
    (ii) Reasonable expenses with respect to investments described in 
subdivision (i) of this subparagraph,
    (iii) Payment of taxes,
    (iv) Any expenses which qualify as deductions in the computation of 
unrelated business income tax under section 511,
    (v) Any payment which constitutes a qualifying distribution under 
section 4942(g) or an allowable deduction under section 4940,
    (vi) Reasonable expenditures to evaluate, acquire, modify, and 
dispose of program-related investments, or
    (vii) Business expenditures by the recipient of a program-related 
investment.
    (2) Conversely, any expenditures for unreasonable administrative 
expenses, including compensation, consultant fees, and other fees for 
services rendered, will ordinarily be taxable expenditures under section 
4945(d)(5) unless the foundation can demonstrate that such expenses were 
paid or incurred in the good faith belief that they were reasonable and 
that the payment or incurrence of such expenses in such amounts was 
consistent with ordinary business care and prudence. The determination 
whether an expenditure is unreasonable shall depend upon the facts and 
circumstances of the particular case.
    (c) Grants to ``noncharitable'' organizations--(1) In general. 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).

For purposes of this paragraph, an organization treated as a section 
509(a)(1) organization under Sec. 53.4945-5(a)(4) shall be treated as 
an organization described in section 501(c)(3).
    (2) Grants other than transfers of assets described in Sec. 1.507-
3(c)(1). (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 Sec. 53.4945-5.
    (ii) For purposes of this paragraph, a foreign organization which 
does not

[[Page 191]]

have a ruling or determination letter that it is an organization 
described in section 501(c)(3) (other than section 509(a)(4)) will be 
treated as an organization described in section 501(c)(3) (other than 
section 509(a)(4)) if in the reasonable judgment of a foundation manager 
of the transferor private foundation, the grantee organization is an 
organization described in section 501(c)(3) (other than section 
509(a)(4)). The term ``reasonable judgment'' shall be given its 
generally accepted legal sense within the outlines developed by judicial 
decisions in the law of trusts.
    (3) Transfers of assets described in Sec. 1.507-3(c)(1). If a 
private foundation makes a transfer of assets (other than a transfer 
described in subparagraph (1)(i) of this paragraph) pursuant to any 
liquidation, merger, redemption, recapitalization, or other adjustment, 
organization, or reorganization to any person, the transferred assets 
will not be considered used exclusively for purposes described in 
section 170(c)(2)(B) unless the assets are transferred to a fund or 
organization described in section 501(c)(3) (other than an organization 
described in section 509(a)(4)) or treated as so described under section 
4947(a)(1).

[T.D. 7215, 37 FR 23161, Oct. 31, 1972, as amended by T.D. 7233, 37 FR 
28162, Dec. 21, 1972]



                 Subpart G_Definitions and Special Rules



Sec. 53.4946-1  Definitions and special rules.

    (a) Disqualified person. (1) For purposes of Chapter 42 and the 
regulations thereunder, the following are disqualified persons with 
respect to a private foundation:
    (i) All substantial contributors to the foundation, as defined in 
section 507 (d)(2) and the regulations thereunder.
    (ii) All foundation managers of the foundation as defined in section 
4946 (b)(1) and paragraph (f)(1)(i) of this section,
    (iii) An owner of more than 20 percent of:
    (a) The total combined voting power of a corporation,
    (b) The profits interest of a partnership,
    (c) The beneficial interest of a trust or unincorporated enterprise.

which is (during such ownership) a substantial contributor to the 
foundation, as defined in section 507(d)(2) and the regulations 
thereunder,
    (iv) A member of the family, as defined in section 4946(d) and 
paragraph (h) of this section, of any of the individuals described in 
subdivision (i), (ii), or (iii) of this subparagraph,
    (v) A corporation of which more than 35 percent of the total 
combined voting power is owned by persons described in subdivision (i), 
(ii), (iii), or (iv) of this subparagraph,
    (vi) A partnership of which more than 35 percent of the profits 
interest is owned by persons described in subdivision (i), (ii), (iii), 
or (iv) of this subparagraph, and
    (vii) A trust, estate, or unincorporated enterprise of which more 
than 35 percent of the beneficial interest is owned by persons described 
in subdivision (i), (ii), (iii), or (iv) of this subparagraph.
    (2) For purposes of subparagraphs (1)(iii) (b) and (vi) of this 
paragraph, the profits interest of a partner shall be equal to his 
distributive share of income of the partnership, as determined under 
section 707(b)(3) and the regulations thereunder as modified by section 
4946(a)(4).
    (3) For purposes of subparagraph (1) (iii)(c) and (vii) of this 
paragraph, the beneficial interest in an unincorporated enterprise 
(other than a trust or estate) includes any right to receive a portion 
of distributions from profits of such enterprise, and, if the portion of 
distributions is not fixed by an agreement among the participants, any 
right to receive a portion of the assets (if any) upon liquidation of 
the enterprise, except as a creditor or employee. For purposes of this 
subparagraph, a right to receive distributions of profits includes a 
right to receive any amount from such profits other than as a creditor 
or employee, whether as a sum certain or as a portion of profits 
realized by the enterprise. Where there is no agreement fixing the 
rights of the participants in such enterprise, the fraction of the 
respective interests of each participant in such enterprise shall be 
determined by dividing the amount of

[[Page 192]]

all investments or contributions to the capital of the enterprise made 
or obligated to be made by such participant by the amount of all 
investments or contributions to capital made or obligated to be made by 
all of them.
    (4) For purposes of subparagraph (1) (iii) (c) and (vii) of this 
paragraph, a person's beneficial interest in a trust shall be determined 
in proportion to the actuarial interest of such person in the trust.
    (5) For purposes of subparagraph (1) (iii) (a) and (v) of this 
paragraph, the term ``combined voting power'' includes voting power 
represented by holdings of voting stock, actual or constructive (under 
section 4946(a)(3)), but does not include voting rights held only as a 
director or trustee.
    (6) For purposes of subparagraph (1) (iii) (a) and (v) of this 
paragraph, the term ``voting power'' includes outstanding voting power 
and does not include voting power obtainable but not obtained, such as, 
for example, voting power obtainable by converting securities or 
nonvoting stock into voting stock or by exercising warrants or options 
to obtain voting stock, and voting power which will vest in preferred 
stockholders only if and when the corporation has failed to pay 
preferred dividends for a specified period of time or has otherwise 
failed to meet specified requirements. Similarly, for purposes of 
subparagraph (1)(iii) (b) and (c), (vi), and (vii) of this paragraph, 
the terms ``profits interest'' and ``beneficial interest'' include any 
such interest that is outstanding, but do not include any such interest 
that is obtainable but has not been obtained.
    (7) For purposes of sections 170(b) (1)(E)(iii), 507(d)(1), 508(d), 
509(a) (1) and (3), and Chapter 42, the term ``disqualified person'' 
shall not include an organization which is described in section 509(a) 
(1), (2), or (3), or any other organization which is wholly owned by 
such section 509(a) (1), (2), or (3) organization.
    (8) 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)).
    (b) Section 4943. (1) For purposes of section 4943 only, the term 
``disqualified person'' includes a private foundation:
    (i) Which is effectively controlled (within the meaning of Sec. 
1.482-1(a)(3) of this chapter), directly or indirectly, by the same 
person or persons (other than a bank, trust company, or similar 
organization acting only as a foundation manager) who control the 
private foundation in question, or
    (ii) Substantially all the contributions to which were made, 
directly or indirectly, by persons described in subdivision (i), (ii), 
(iii), or (iv) of paragraph (a)(1) of this section who made, directly or 
indirectly, substantially all of the contributions to the private 
foundation in question.
    (2) For purposes of subparagraph (1)(ii) of this paragraph, one or 
more persons will be considered to have made substantially all of the 
contributions to a private foundation, if such persons have contributed 
or bequeathed at least 85 percent (and each such person has contributed 
or bequeathed at least 2 percent) of the total contributions and 
bequests (within the meaning of section 507(d)(2) and the regulations 
thereunder) which have been received by such private foundation during 
its entire existence.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, a private foundation, has a board of directors made up 
of X, Y, Z, M, N, and O. Foundation B's board of directors is made up of 
Y, M, N, and O. The board of directors in each case has plenary power to 
determine the manner in which the foundation is operated. For purposes 
of section 4943, foundation A is a disqualified person with respect to 
foundation B, and foundation B, is a disqualified person with respect to 
foundation A.
    Example 2. Private foundation A has received contributions of 
$100,000 throughout its existence: $35,000 from X, $51,000 from Y (who 
is X's father), and $14,000 from Z (an unrelated person). Private 
foundation B has received $100,000 in contributions during its 
existence: $50,000 from X and $50,000 from W, X's wife.


For purposes of section 4943, private foundation A is a disqualified 
person with respect to private foundation B, and private foundation B is 
a disqualified person with respect to private foundation A.


[[Page 193]]


    (c) Section 4941. For purposes of section 4941, a government 
official, as defined in section 4946(c) and paragraph (g) of this 
section, is a disqualified person.
    (d) Attribution of stockholdings. (1) For purposes of paragraph 
(a)(1)(iii) (a) and (v) of this section, indirect stockholdings shall be 
taken into account under section 267(c) and the regulations thereunder. 
However, for purposes of this paragraph:
    (i) Section 267(c)(4) shall be treated as though it provided that 
the members of the family of an individual are the members within the 
meaning of section 4946(d) and paragraph (h) of this section; and
    (ii) Any stockholdings which have been counted once (whether by 
reason of actual or constructive ownership) in applying section 
4946(a)(1)(E) shall not be counted a second time.

For purposes of paragraph (a)(1)(v) or this section, section 267(c) 
shall be applied without regard to section 267(c)(3), and stock 
constructively owned by an individual by reason of the application of 
section 267(c)(2) shall not be treated as owned by him if he is 
described in section 4946(a)(1)(D) but not also in section 4946(a)(1) 
(A), (B), or (C).
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. D is a substantial contributor to private foundation Y. D 
owns 20 percent of the outstanding stock of corporation P. E, D's wife, 
owns none of the outstanding stock of P. F, E's father, owns 10 percent 
of the outstanding stock of P. E is treated under section 507(d)(2) as a 
substantial contributor to Y. E is also treated under section 267(c)(2) 
as owning both D's 20 percent and F's 10 percent of P, but E is treated 
as owning nothing for purposes of section 4946(a)(1)(E) because D's 20 
percent and F's 10 percent have already been taken into account once 
(because of their actual ownership of the stock of P) for such purposes. 
Hence, corporation P is not a disqualified person under section 
4946(a)(1)(E) with respect to private foundation Y because persons 
described in section 4946(a)(1) (A), (B), (C), and (D) own only 30 
percent of the stock of P.
    Example 2. I, a substantial contributor to private foundation X, is 
the son of J. I owns 100 percent of the stock of corporation R, which in 
turn owns 18 percent of the stock of corporation S. J owns 18 percent of 
the stock of S. I constructively owns 36 percent of the stock of S (J's 
18 percent plus R's 18 percent). Both J's actual holdings and R's actual 
holdings are counted in determining I's constructive holdings because 
this does not result in counting either of the holdings more than once 
for purposes of section 4946 (a)(1)(E). Therefore, S is a disqualified 
person with respect to private foundation X, since I, a substantial 
contributor, constructively owns more than 35 percent of S's stock.

    (e) Attribution of profits or beneficial interests. (1) For purposes 
of paragraph (a) (1) (iii) (b), (iii) (c) (vi), and (vii) of this 
section, ownership of profits or beneficial interests shall be taken 
into account as though such ownership related to stockholdings, if such 
stockholdings would be taken into account under section 267(c) and the 
regulations thereunder, except that section 267(c)(3) shall not apply to 
attribute the ownership of one partner to another solely by reason of 
such partner relationship. However, for purposes of this paragraph:
    (i) Section 267(c)(4) shall be treated as though it provided that 
the members of the family of an individual are the members within the 
meaning of section 4946(d) and paragraph (h) of this section; and
    (ii) Any profits interest or beneficial interest which has been 
counted once (whether by reason of actual or constructive ownership) in 
applying section 4946(a)(1) (F) or (G) shall not be counted a second 
time.

For purposes of paragraph (a)(1) (vi) and (vii) of this section, profits 
or beneficial interests constructively owned by an individual by reason 
of the application of section 267(c)(2) shall not be treated as owned by 
him if he is described in section 4946(a)(1)(D) but not in section 
4946(a)(1)(A), (B) or (C).
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Partnership S is a substantial contributor to private 
foundation X. Trust T, of which G is sole beneficiary, owns 12 percent 
of the profits interest of S. G's husband, H, owns 10 percent of the 
profits interest of S. H is a disqualified person with respect to X 
(under section 4946(a)(1)(C)) because he is considered to own 22 percent 
of the profits interest of S (10 percent actual ownership, plus G's 12 
percent constructively under section 267(c)(2)). G is a disqualified 
person with

[[Page 194]]

respect to X (under section 4946(a)(1)(C) because she is considered to 
own 22 percent of the profits interest of S (12 percent constructively 
by reason of her beneficial interest in trust T, plus 10 percent 
constructively under section 267(c)(2) by reason of being a member of 
the family of H).

    (f) Foundation manager. (1) For purposes of Chapter 42 and the 
regulations thereunder, the term ``foundation manager'' means:
    (i) An officer, director, or trustee of a foundation (or a person 
having powers or responsibilities similar to those of officers, 
directors, or trustees of the foundation), and
    (ii) With respect to any act or failure to act, any employee of the 
foundation having final authority or responsibility (either officially 
or effectively) with respect to such act or failure to act.
    (2) For purposes of subparagraph (1)(i) of this paragraph, a person 
shall be considered an officer of a foundation if:
    (i) He is specifically so designated under the certificate of 
incorporation, bylaws, or other constitutive documents of the 
foundation; or
    (ii) He regularly exercises general authority to make administrative 
or policy decisions on behalf of the foundation.

With respect to any act or failure to act, any person described in 
subdivision (ii) of this subparagraph who has authority merely to 
recommend particular administrative or policy decisions, but not to 
implement them without approval of a superior, is not an officer. 
Moreover, such independent contractors as attorneys, accountants, and 
investment managers and advisers, acting in their capacities as such, 
are not officers within the meaning of subparagraph (1)(i) of this 
paragraph.
    (3) For purposes of subparagraph (1)(ii) of this paragraph, an 
individual rendering services to a private foundation shall be 
considered an employee of the foundation only if he is an employee 
within the meaning of section 3121(d)(2).
    (4) Since the definition of the term ``disqualified person'' 
contained in section 4946(a)(1)(B) incorporates only so much of the 
definition of the term ``foundation manager'' as is found in section 
4946(b)(1) and subparagraph (1)(i) of this paragraph, any references, in 
section 4946 and this section, to ``disqualified persons'' do not 
constitute references to persons who are ``foundation managers'' solely 
by reason of the definition of that term contained in section 4946(b)(2) 
and subparagraph (1)(ii) of this paragraph.
    (g) Government official--(1) In general. Except as provided in 
subparagraph (3) of this paragraph, for purposes of section 4941 and 
paragraph (c) of this section, the term ``government official'' means, 
with respect to an act of selfdealing described in section 4941, an 
individual who, at the time of such act, is described in subdivision 
(i), (ii), (iii), (iv), or (v) of this subparagraph (other than a 
``special Government employee'' as defined in 18 U.S.C. 202(a)):
    (i)(a) An individual who holds an elective public office in the 
executive or legislative branch of the Government of the United States.
    (b) An individual who holds an office in the executive or judicial 
branch of the Government of the United States, appointment to which was 
made by the President.
    (ii) An individual who holds a position in the executive, 
legislative or judicial branch of the Government of the United States:
    (a) Which is listed in schedule C of rule VI of the Civil Service 
Rules, or
    (b) The compensation for which is equal to or greater than the 
lowest rate prescribed for GS-16 of the General Schedule under 5 U.S.C. 
5332.
    (iii) An individual who holds a position under the House of 
Representatives or the Senate of the United States, as an employee of 
either of such bodies, who receives gross compensation therefrom at an 
annual rate of $15,000 or more.
    (iv) The holder of an elective or appointive public office in the 
executive, legislative, or judicial branch of the government of a State, 
possession of the United States, or political subdivision or other area 
of any of the foregoing, or of the District of Columbia, for which the 
gross compensation is at an annual rate of $15,000 or more, who is 
described in subparagraph (2) of this paragraph.

[[Page 195]]

    (v) The holder of a position as personal or executive assistant or 
secretary to any individual described in subdivision (i), (ii), (iii), 
or (iv) of this subparagraph.
    (2) Public office--(i) Definition. In defining the term ``public 
office'' for purposes of section 4946(c)(5) and subparagraph (1)(iv) of 
this paragraph, such term must be distinguished from mere public 
employment. Although holding a public office is one form of public 
employment, not every position in the employ of a State or other 
governmental subdivision (as described in section 4946 (c)(5)) 
constitutes a ``public office''. Although a determination whether a 
public employee holds a public office depends on the facts and 
circumstances of the case, the essential element is whether a 
significant part of the activities of a public employee is the 
independent performance of policymaking functions. In applying this 
subparagraph, several factors may be considered as indications that a 
position in the executive, legislative, or judicial branch of the 
government of a State, possession of the United States, or political 
subdivision or other area of any of the foregoing, or of the District of 
Columbia, constitutes a ``public office''. Among such factors to be 
considered in addition to that set forth above, are that the office is 
created by the Congress, a State constitution, or the State legislature, 
or by a municipality or other governmental body pursuant to authority 
conferred by the Congress, State constitution, or State legislature, and 
the powers conferred on the office and the duties to be discharged by 
such office are defined either directly or indirectly by the Congress, 
State constitution, or State legislature, or through legislative 
authority.
    (ii) Illustrations. The following are illustrations of positions of 
public employment which do not involve policymaking functions within the 
meaning of subdivision (i) of this subparagraph and which are thus not a 
``public office'' for purposes of section 4946(c)(5) and subparagraph 
(1)(iv) of this paragraph:
    (a) The chancellor, president, provost, dean, and other officers of 
a State university who are appointed, elected, or otherwise hired by a 
State Board of Regents or equivalent public body and who are subject to 
the direction and supervision of such body;
    (b) Professors, instructors, and other members of the faculty of a 
State educational institution who are appointed, elected, or otherwise 
hired by the officers of the institution or by the State Board of 
Regents or equivalent public body;
    (c) The superintendent of public schools and other public school 
officials who are appointed, elected, or otherwise hired by a Board of 
Education or equivalent public body and who are subject to the direction 
and supervision of such body;
    (d) Public school teachers who are appointed, elected, or otherwise 
hired by the superintendent of public schools or by a Board of Education 
or equivalent public body;
    (e) Physicians, nurses, and other professional persons associated 
with public hospitals and State boards of health who are appointed, 
elected, or otherwise hired by the governing board or officers of such 
hospitals or agencies; and
    (f) Members of police and fire departments, except for those 
department heads who, under the facts and circumstances of the case, 
independently perform policymaking functions as a significant part of 
their activities.
    (3) Certain government officials on leave of absence. For purposes 
of this paragraph, an individual who is otherwise described in section 
4946(c) and this paragraph who was on leave of absence without pay on 
December 31, 1969, from his position or office pursuant to a commitment 
entered into on or before such date to engage in certain activities for 
which he is paid by one or more private foundations, is not to be 
treated as holding such position or office for any continuous period 
after December 31, 1969, and prior to January 1, 1971, during which such 
individual remains on leave of absence to engage in the same activities 
for which he is paid by such foundations. For purposes of this 
subparagraph, a commitment is considered entered into on or before 
December 31, 1969, if on or before such date, the amount and nature of 
the payments to be made and the name of the

[[Page 196]]

individual receiving such payments were entered on the records of the 
payor, or were otherwise adequately evidenced, or the notice of the 
payment to be received was communicated to the payee orally or in 
writing.
    (h) Members of the family. For purposes of this section, the members 
of the family of an individual include only:
    (1) His spouse,
    (2) His ancestors,
    (3) His lineal descendants, and
    (4) Spouses of his lineal descendants.

For example, a brother or sister of an individual is not a member of his 
family for purposes of this section. However, for example, the wife of a 
grandchild of an individual is a member of his family for such purposes. 
For purposes of this paragraph, a legally adopted child of an individual 
shall be treated as a child of such individual by blood.

[T.D. 7241, 37 FR 28744, Dec. 29, 1972]



            Subpart H_Application to Certain Nonexempt Trusts



Sec. 53.4947-1  Application of tax.

    (a) In general. Section 4947 subjects trusts which are not exempt 
from taxation under section 501(a), all or part of the unexpired 
interests in which are devoted to one or more of the purposes described 
in section 170(c)(2)(B), and which have amounts in trust for which a 
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 to the same requirements and restrictions as 
are imposed on private foundations. The basic purpose of section 4947 is 
to prevent these trusts from being used to avoid the requirements and 
restrictions applicable to private foundations. For purposes of this 
section, a trust shall be presumed (in the absence of proof to the 
contrary) to have amounts under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522 if a deduction would have been 
allowable under one of these sections. Also for purposes of this section 
and Sec. 53.4947-2, the term ``purposes described in section 
170(c)(2)(B)'' shall be treated as including purposes described in 
section 170(c)(1).
    (b) Charitable trusts--(1) General rule. (i) For purposes of this 
section and Sec. 53.4947-2, a charitable trust, within the meaning of 
section 4947(a)(1), is a trust which is not exempt from taxation under 
section 501(a), all of the unexpired interests in which are devoted to 
one or more of the purposes described in section 170(c)(2)(B), and for 
which a deduction was allowed under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522 (or the corresponding provisions of 
prior law). A trust is one for which a deduction was allowed under 
section 642(c), within the meaning of section 4947(a)(1), once a 
deduction is allowed under section 642(c) to the trust for any amount 
paid or permanently set aside. (See sections 642(c) and Sec. 1.642-4 
for the limitation on such deduction in certain cases.) A charitable 
trust (as defined in this paragraph) shall be treated as an organization 
described in section 501(c)(3) and, if it is determined under section 
509 that the trust is a private foundation, then Part II of Subchapter F 
of chapter 1 of the Code (other than section 508 (a), (b) and (c) and 
Chapter 42 shall apply to the trust. However, the charitable trust is 
not treated as an organization described in section 501(c)(3) for 
purposes of exemption from taxation under section 501(a). Thus, the 
trust is subject to the excise tax on its investment income under 
section 4940(b) rather than the tax imposed by section 4940(a). For 
purposes of satisfying the organizational test described in Sec. 1.501 
(c)(3)-1(b) when a charitable trust seeks an exemption from taxation 
under section 501(a), a charitable trust (as defined in this paragraph) 
shall be considered organized on the day it first becomes subject to 
section 4947(a)(1). However, for purposes of the special and 
transistional rules in section 4940(c)(4)(B), 4942(f)(4), 
4943(c)(4)(A)(i) and (B) and section 101(1)(2)(A), (B), (C), and (D), 
and (1)(3) of the Tax Reform Act of 1969, a charitable trust (as defined 
in this paragraph) shall be considered organized on the first day it has 
amounts in trust for which a deduction was allowed (within the meaning 
of paragraph (a) of this section) under section 170, 545(b)(2), 
556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. Thus, under this

[[Page 197]]

rule, a trust may be treated as a private foundation in existence on a 
date governing one of the applicable special and transistional rules 
even though the trust did not otherwise become subject to the provisions 
of Chapter 42 until a later date.
    (ii) The provisions of paragraph (b)(1) of this section may be 
illustrated by the following examples:

    Example 1. On January 30, 1970, X creates an inter vivos trust under 
which M receives 50 percent and N receives 50 percent of the trust's 
income for 10 years, and upon the termination of which, at the end of 
the 10-year period, the corpus is to be distributed to O. M, N and O are 
all organizations described in section 501(c)(3) and X is allowed a 
deduction under section 170 for the value of all interests placed in 
trust. The trustees of the trust do not give notice to the Internal 
Revenue Service under the provisions of section 508(a), and the trust 
will therefore not be exempt from taxation under section 501(a). The 
trust is a charitable trust within the meaning of section 4947(a)(1) 
from the date of its creation.
    Example 2. On March 1, 1971, Y creates a charitable remainder 
annuity trust described in section 664(d)(1) under which Z, Y's son, 
receives $10,000 per year for life, remainder to be held in trust for P, 
an organization described in section 501(c)(3). Y is allowed a deduction 
under section 170 for the present value of the remainder interest to P. 
During Z's lifetime, the trust is a split-interest trust described in 
section 4947(a)(2) and paragraph (c) of this section. Upon the death of 
Z, all unexpected interests (consisting of P's remainder interest) will 
be devoted to section 170(c)(2)(B) purposes. Except as provided in Sec. 
53.4947-1(b)(2)(iv) (relating to a reasonable period of settlement) the 
trust will be treated as a charitable trust within the meaning of 
section 4947(a)(1) from the date of the death of Z unless the trustees 
of the trust apply for recognition of section 501(c)(3) status under the 
provisions of section 508(a).

    (2) Scope of application of section 4947(a)(1)--(i) In general. 
Subject to paragraph (b)(2) (ii) through (vii) of this section, section 
4947(a)(1) applies to nonexempt trusts in which all unexpired interests 
are charitable. For purposes of this section, the term charitable when 
used to describe an interest or beneficiary refers to the purposes 
described in section 170(c)(2)(B). An estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
to such beneficiaries will not be considered a charitable trust under 
section 4947(a)(1) during the period of estate administration or 
settlement, except as provided in paragraph (b)(2)(ii) of this section. 
A charitable trust created by will shall be considered a charitable 
trust under section 4947(a)(1) as of the date of death of the decedent-
grantor, except as provided in paragraph (b)(2)(v) of this section 
(relating to trusts which wind up. For the circumstances under which 
segregated amounts are treated as charitable trusts, see Sec. 53.4947-
1(c)(3)(iii).
    (ii) Estates. (A) When an estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
for charitable beneficiaries, or free of trust to such beneficiaries, is 
considered terminated for Federal income tax purposes under Sec. 
1.641(b)-3(a), then the estate will be treated as a charitable trust 
under section 4947(a)(1) between the date on which the estate is 
considered terminated under Sec. 1.641(b)-3(a) and the date final 
distribution of all of the net assets is made to or for the benefit of 
the charitable beneficiaries. This (ii) does not affect the 
determination of the tax liability under Subtitle A of the beneficiaries 
of the estates.
    (B) The provisions of this (ii) may be illustrated by the following 
example:

    Example. X bequeaths his entire estate, including 100 percent of the 
stock of a wholly-owned corporation, to M, an organization described in 
section 501(c)(3), under a will which gives his executor authority to 
hold the stock and manage the corporation for a period of up to 10 years 
for the benefit of M prior to its ultimate disposition. A deduction for 
the charitable bequest was allowed to X's estate under section 2055. The 
executor is vested with a full range of powers, including the power of 
sale. Upon the death of X, his executor distributes X's assets to M 
except for the stock of the corporation, which he holds for 5 years 
prior to its disposition. The continued holding of the stock of the 
corporation by the executor after the expiration of a reasonable time 
for performance of all the ordinary duties of administration causes the 
estate to be considered terminated for Federal income tax purposes 
pursuant to Sec. 1.641(b)-3(a) and thereby subjects it to the 
provisions of section 4947(a)(1) from the date of such termination to 
the date of final disposition of the stock of the corporation.


[[Page 198]]


    (iii) Certain split-interest trusts which wind up. A split-interest 
trust (as defined in paragraph (c) of this section) in which all of the 
unexpired interests are charitable remainder interests and in which the 
charitable beneficiaries have become entitled to distributions of corpus 
in trust or free of trust shall continue to be treated as as split-
interest trust under section 4947(a)(2) until the date on which final 
distribution of all the net assets is made. However, if after the 
expiration of any intervening interests the trust is considered 
terminated for Federal income tax purposes under Sec. 1.641(b)-3(b), 
then the trust will be treated as a charitable trust under section 
4947(a)(1), rather than a split interest trust under section 4947(a)(2), 
between the date on which the trust is considered terminated under Sec. 
1.641(b)-3(b) and the date on which such final distribution of all of 
the net assets is made to or for the benefit of the charitable remainder 
beneficiaries. This (iii) does not affect the determination of the tax 
liability under subtitle A of the beneficiaries of the trusts.
    (iv) Split-interest trusts which become charitable trusts. (A) A 
split-interest trust (as defined in paragraph (c) of this section) in 
which all of the unexpired interests are charitable remainder interests 
and in which some or all of the charitable beneficiaries are not 
entitled to distributions of corpus within the meaning of paragraph 
(b)(2)(iii) of this section shall continue to be treated as a split-
interest trust under section 4947(a)(2) rather than a charitable trust 
under section 4947(a)(1) for a reasonable period of settlement after the 
expiration of the noncharitable interest. Thus, a split-interest trust 
which under its terms is to continue to hold assets for charitable 
beneficiaries after the expiration of the noncharitable interest rather 
than distributing them as in paragraph (b)(2)(iii) of this section is 
given a reasonable period of settlement before being treated as a 
charitable trust. For purposes of this paragraph, the term reasonable 
period of settlement means that period reasonably required (or if 
shorter, actually required) by the trustee to perform the ordinary 
duties of administration necessary for the settlement of the trust. 
These duties include, for example, the collection of assets, the payment 
of debts, taxes, and distributions, and the determination of the rights 
of the subsequent beneficiaries.
    (B) This (iv) may be illustrated by the following example:

    Example. On January 15, 1971, A creates a charitable remainder 
annuity trust described in section 661(d)(1) under which the trustees 
are required to distribute $10,000 a year to B, A's wife, for life, 
remainder to be held in trust for the use of M, an organization 
described in section 501(c)(3). A is allowed a deduction under section 
170 for the amount of the charitable interest, and the trust is, 
therefore, treated as a split-interest trust under section 4947(a)(2) 
from the date of its creation. B dies on February 10, 1975. On April 15, 
1975, the trustees complete performance of the ordinary duties of 
administration necessary for the settlement of the trust brought about 
by the death of B. These duties include, for example, an accounting for 
and payment to the estate of B of amounts accrued by B while alive 
during 1975. However, the trustees do not distribute the corpus to M by 
April 15, 1975. The trust shall continue to be treated as a split-
interest trust under section 4947(a)(2) until April 15, 1975. After 
April 15, 1975, the trust shall be treated as a charitable trust under 
section 4947(a)(1).

    (v) Certain revocable and testamentary trusts which wind up. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required 
to distribute all of the net assets in trust for or free of trust to 
charitable beneficiaries is not considered a charitable trust under 
section 4947(a)(1) for a reasonable period of settlement (within the 
meaning of paragraph (b)(2)(iv) of this section) after becoming 
irrevocable. After that period the trust is considered a charitable 
trust under section 4947(a)(1).
    (vi) Revocable trusts which become charitable trusts. A revocable 
trust that becomes irrevocable upon the death of the decedent-grantor in 
which all of the unexpired interests are charitable and under the terms 
of the governing instrument of which the trustee is required to hold 
some or all of the net assets in trust after becoming irrevocable solely 
for charitable beneficiaries is not considered a trust under section

[[Page 199]]

4947(a)(1) for a reasonable period of settlement (within the meaning of 
paragraph (b)(2)(iv) of this section) after becoming irrevocable except 
that section 4941 may apply if the requirements of Sec. 53.4941(d)-1 
(b)(3) are not met. After that period, the trust is considered a 
charitable trust under section 4947(a)(1).
    (vii) Trust devoted to 170(c) purposes. (A) A trust all of the 
unexpired interests in which are devoted to section 170 (c) (3) or (5) 
purposes together with section 170(c)(2)(B) purposes shall be considered 
a charitable trust except that payments under the terms of the governing 
instrument to an organization described in section 170(c) (3) or (5) 
shall not be considered a violation of section 4945(d)(5) or any other 
provisions of Chapter 42 and shall be considered qualifying 
distributions under section 4942.
    (B) Example. The application of paragraph (b)(2)(vii) of this 
section may be illustrated by the following example:

    Example. On January 30, 1970, H creates an inter vivos trust under 
the terms of the governing instruments of which M, an organization 
described in section 170(c)(3), and N, an organization described in 
section 501(c)(3), are each to receive 50 percent of the income for a 
period of 10 years. At the end of the 10 year period, the corpus is to 
be distributed to O, an organization also described in section 
501(c)(3). H is allowed a deduction under section 170 for the value of 
all interests placed in trust. The payments to M do not constitute a 
violation of section 4945(d)(5) or any other provision of Chapter 42 and 
constitute qualifying distributions under section 4942. However, except 
as provided in the previous sentence, the trust shall be considered a 
charitable trust.

    (3) Charitable trusts described in section 509(a)(3). For purposes 
of section 509(a)(3)(A), a charitable trust shall be treated as if 
organized on the day on which it first becomes subject to section 
4947(a)(1). However, for purposes of applying Sec. Sec. 1.509(a)-4(d) 
(2)(iv)(a), and 1.509(a)-4(i)(1) (ii) and (iii)(c) the previous 
relationship between the charitable trust and the section 509(a) (1) or 
(2) organizations it benefits or supports may be considered. If the 
charitable trust otherwise meets the requirements of section 509(a)(3), 
it may obtain recognition of its status as a section 509(a)(3) 
organization by requesting a ruling from the Internal Revenue Service. 
For the special rules pertaining to the application of the 
organizational test to organizations terminating their private 
foundation status under the 12-month or 60-month termination period 
provided under section 507(b)(1)(B) by becoming ``public'' under section 
509(a)(3), see the regulations under section 507(b)(1).
    (c) Split-interest trusts--(1) General rule--(i) Definition. For 
purposes of this section and Sec. 53.4947-2, a split-interest trust, 
within the meaning of section 4947(a)(2), is a trust which is not exempt 
from taxation under section 501(a), not all of the unexpired interests 
in which are devoted to one or more of the purposes described in section 
170(c)(2)(B), and which has amounts in trust for which a deduction was 
allowed (within the meaning of paragraph (a) of this section) under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. A 
trust is one which has amounts in trust for which a deduction was 
allowed under section 642(c) within the meaning of section 4947(a)(2) 
once a deduction is allowed under section 642(c) to the trust for any 
amount permanently set aside. This (i) also includes any trust which is 
not treated as a charitable trust by operation of paragraph (b)(2) (iii) 
or (iv) of this section (relating to split-interest trusts in the 
process of winding up or during a reasonable period of settlement). 
Section 4947(a)(1) shall apply to a trust described in this (i) (without 
regard to section 4947(a)(2)(A), (B), or (C)) from the first date upon 
which the provisions of paragraph (b)(2) (iii) or (iv) of this section 
are satisfied. For the circumstances under which a trust all of the 
unexpired interests in which are devoted to section 170(c) (3) or (5) 
purposes together with section 170(c)(2)(B) purposes is considered a 
charitable trust, see Sec. 53.4947-1(b)(2)(vii).
    (ii) Applicability of statutory rules. A split-interest trust is 
subject to the provisions of section 507 (except as provided in 
paragraph (e) of this section), 508(e) (to the extent applicable to a 
split-interest trust), 4941, 4943 (except as provided in section 
4947(b)(3)), 4944 (except as provided in section 4947(b)(3)), and 4945 
in the same manner

[[Page 200]]

as if such trust were a private foundation.
    (iii) Special rules. A newly created trust shall, for purposes of 
section 4947(a)(2), be treated as having amounts in trust for which a 
deduction was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 from the date of its creation, even if a 
deduction was allowed for such amounts only at a later date. For 
purposes of this (iii), the date of creation of a charitable remainder 
trust shall be determined by applying the rules in Sec. 1.664-1(a)(4).
    (2) Exception for amounts payable to income beneficiaries. (i) Under 
section 4947(a)(2)(A), paragraph (c)(1)(ii) of this section does not 
apply to any amounts payable under the terms of a split-interest trust 
to income beneficiaries unless a deduction was allowed under section 
170(f)(2)(B), 2055(e)(2) (B), or 2522(c)(2)(B) with respect to the 
income interest of any such beneficiary. See Sec. 1.170A-6(c), Sec. 
20.2055(e)(2), and Sec. 25.2522(c)-3(c)(2) for rules regarding the 
allowance of these deductions. However, section 4947(a)(2)(A) does not 
apply when the value of all interests in property transferred in trust 
are deductible under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522.
    (ii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. H creates a charitable remainder unitrust (described in 
section 664(d)(2)) which is required annually to pay W, H's wife, 5 
percent of the net fair market value of the trust assets, valued 
annually, for her life; and to pay the remainder to Y, a section 
501(c)(3) organization. A deduction under section 170(f)(2)(A) was 
allowed with respect to the remainder interest of Y. Under section 
4947(a)(2)(A), each annual amount which becomes payable to W during her 
life is not subject to paragraph (c)(1)(ii) of this section on or after 
the date upon which it becomes so payable and the payment of each amount 
to W is not an act of self-dealing under section 4941(d)(1) and does not 
violate any other provision of chapter 42. However, except as provided 
in the preceding sentence, the trust is subject to paragraph (c)(1)(ii) 
of this section in the same manner as any other split-interest trust.
    Example 2. H bequeaths the residue of his estate in trust for the 
benefit of S, his son, and Y, an organization described in section 
501(c)(3). A guaranteed annuity interest of $10,000 is to be paid to S 
for 20 years. A guaranteed annuity interest of $5,000 which meets the 
requirements contained in Sec. 20.2055-2(e)(2)(v)(a) is also to be paid 
to Y for 20 years. Upon termination of the 20-year term, the corpus is 
to be distributed to Z, another organization described in section 
501(c)(3). The trust is a charitable remainder annuity trust as 
described in section 664(d)(1) and the regulations thereunder, and a 
deduction under section 2055(e)(2)(A) was allowed with respect to the 
remainder interest of Z. A deduction was also allowed under section 
2055(e)(2)(B) with respect to the guaranteed annuity interest of Y. The 
assets in the trust are not segregated under section 4947(a)(2)(B) and 
paragraph (c)(3) of this section. Under section 4947(a)(2)(A), each 
payment of $10,000 to S is not subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section. The payment of each amount to S is 
not an act of self-dealing under section 4941(d)(1) and does not violate 
any other provision of chapter 42. However, except as provided in the 
preceding sentence, the trust is subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section in the same manner as any other 
split-interest trust.
    Example 3. H creates a trust under which the trustees are required 
to pay over an annuity interest of $20,000 to W. H's wife, for her life. 
A guaranteed annuity interest of $10,000 which meets the requirements 
contained in Sec. 25.2522(c)-3(c)(2)(v) is also to be paid X, an 
organization described in section 501(c)(3), for the life of W. Upon the 
death of W, the corpus of the trust, which consists of office buildings 
M and N, is to be distributed to S. H's son. H received a deduction 
under section 2522(c)(2)(B) for the value of X's income interest in the 
trust. The assets in the trust are not segregated under section 
4947(a)(2)(B) and paragraph (c)(3) of this section. Under section 
4947(a)(2)(A), each payment of $20,000 to W is not subject to section 
4947(a)(2) and paragraph (c)(1)(ii) of this section. The payment of each 
amount to W is not an act of self-dealing under section 4941(d)(1) and 
does not violate any other provision of chapter 42. However, except as 
provided in the preceding sentence, the trust is subject to paragraph 
(c)(1)(ii) of this section in the same manner as any other split-
interest trust. See example (1) of paragraph (c)(3)(v) of this section 
for the application of section 4947(a)(2)(B) to a similar trust where 
the trustees segregate the assets of the trust.

    (3) Exception for certain segregated amount--(i) In general. Under 
section 4947(a)(2)(B) paragraph (c)(1)(ii) of this section does not 
apply to assets held in trust (together with the income and capital 
gains derived from the assets), which are segregated from other assets 
held in trust for which a deduction was

[[Page 201]]

allowed for an income or remainder interest under section 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522.
    (ii) Segregation of amounts. Amounts will generally be considered 
segregated (within the meaning of section 4947(a)(2)(B) if:
    (A) Assets with respect to which no deduction was allowed (for an 
income or remainder interest) under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522, are separately accounted for under 
section 4947(a)(3) and paragraph (c)(4) of this section from assets for 
which such a deduction was allowed for any income or remainder interest 
and,
    (B) By reason of the separate accounting the trust can be treated as 
two separate trusts, one of which is devoted exclusively to 
noncharitable income and remainder interests and the other of which is a 
charitable trust described in section 4947(a)(1) or a split-interest 
trust described in section 4947(a)(2).

Under these circumstances, only the ``trust'' which is devoted 
exclusively to noncharitable income and remainder interests will be 
considered a segregated amount which under section 4947(a)(2)(B), is not 
subject to section 4947(a)(2) and paragraph (c)(1)(ii) of this section.
    (iii) Exclusively charitable amounts. If, under section 
4947(a)(2)(B),
    (A) An amount held in trust which is devoted exclusively to 
noncharitable income and remainder interests is segregated from
    (B) An amount held in trust which is devoted exclusively to 
charitable income and remainder interests,

Then for purposes of this section the amount described in paragraph 
(c)(3)(iii)(B) of this section will be treated as a charitable trust 
which is subject to the provisions of section 4947(a)(1).
    (iv) Charitable and noncharitable amounts. If, under section 4947(a) 
(2)(B),
    (A) An amount held in trust which is devoted exclusively to 
noncharitable income and remainder interests is segregated from
    (B) An amount held in trust which is devoted to both charitable 
income or remainder interests and noncharitable income or remainder 
interests,

Then for purposes of this section the amount described in paragraph 
(c)(3)(iv)(B) of this section will be treated as a split-interest trust 
which is subject to the provisions of section 4947(a)(2).
    (v) Examples. The application of paragraph (c)(3) of this section 
may be illustrated by the following examples:

    Example 1. H creates a trust under which the trustees are required 
to pay over annually 5 percent of the net fair market value of M 
building, valued annually, to W, H's wife, for life, remainder to S, H's 
son. The other asset in the trust is N building, with respect to which 
the trustees are required to pay over annually 5 percent of the net fair 
market value of the building, valued annually, to X, a section 501(c)(3) 
organization, for a period of 15 years, remainder to S. Each asset is 
separately accounted for under section 4947(a)(3) and paragraph (c)(4) 
of this section. He received a deduction under section 2522 for the 
value of X's income interest in N building. Under these circumstances, M 
building is considered segregated (within the meaning of section 
4947(a)(2)(B)) from N building and is not subject to section 4947 
(a)(2). The remainder interest of S in N building is not considered 
segregated from the income interest of X in N building, since both are 
interests in the same asset. N building is considered held in a split-
interest trust which is subject to section 4947 (a)(2) and paragraph 
(c)(1)(ii) of this section.
    Example 2. H transfers $50,000 in trust to pay $2,500 per year to Z, 
a section 501(c)(3) organization, for a term of 20 years, remainder to 
S. H's son. H is allowed a deduction under section 2522 for the present 
value of Z's income interest. The income interest of Z in the trust 
asset cannot be segregated (within the meaning of section 4947(a)(2)(B)) 
from the remainder interest of S since both are interests in the same 
asset. Therefore, the entire trust is subject to section 4947(a)(2) and 
paragraph (c)(1)(ii) of this section.

    (4) Accounting for segregated amounts--(i) General rule. Under 
section 4947(a)(2)(B), a trust with respect to which amounts are 
segregated within the meaning of paragraph (c)(3) of this section must 
separately account for the various income, deduction, and other items 
properly attributable to each segregated amount in the books of account 
and separately account to each of the beneficiaries of the trust.
    (ii) Method. Separate accounting shall be made:

[[Page 202]]

    (A) According to the method regularly employed by the trust, if the 
method is reasonable, and
    (B) In all other cases in a manner which, in the opinion of the 
Commissioner, is reasonable.

A method of separate accounting will be considered ``regularly 
employed'' by a trust when the method has been consistently followed in 
prior taxable years or when a trust which has never before maintained 
segregated amounts initiates a reasonable method of separate accounting 
for its segregated amounts and consistently follows such method 
thereafter. The trust shall keep permanent records and other data 
relating to the segregated amounts as are necessary to enable the 
district director to determine the correctness of the application of the 
rules prescribed in paragraph (c) (3) and (4) of this section.
    (5) Amounts transferred in trust before May 27, 1969--(i) General 
rule. Under section 4947(a)(2)(C), paragraph (c)(1)(ii) of this section 
does not apply to any amounts transferred in trust before May 27, 1969. 
For purposes of this (5), an amount shall be considered to be 
transferred in trust only when the transfer is one which meets the 
requirements for the allowance of a deduction under section 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 (or the 
corresponding provisions of prior law). Income and capital gains which 
are derived at any time from amounts transferred in trust before May 27, 
1969, shall also be excluded from the application of paragraph 
(c)(1)(ii) of this section. If an asset which was transferred in trust 
before May 27, 1969, is sold or exchanged after May 26, 1969, any asset 
received by the trust upon the sale or exchange shall be treated as an 
asset which was transferred in trust before May 27, 1969.
    (ii) Requirement for separate accounting for amounts transferred in 
trust before May 27, 1969. If:
    (A) Amounts are transferred in trust after May 26, 1969, and the 
trust to which the amounts are transferred also contains
    (B) Amounts transferred in trust before May 27, 1969,

the general rule of paragraph (c)(5)(i) of this section applicable to 
the amounts described in paragraph (c)(5)(ii)(B) of this section will 
apply only if the amounts described in paragraph (c)(5)(ii)(A) of this 
section (together with all income and capital gains derived therefrom) 
are separately accounted for (within the meaning of paragraph (c)(4) of 
this section) from the amounts described in paragraph (c)(5)(ii)(B) of 
this section, together with all income and capital gains derived 
therefrom. For the application of section 508(e) to a trust with respect 
to which amounts were transferred both before and after May 27, 1969, 
see section 508(e) and the regulations thereunder.
    (iii) Exception for certain testamentary trusts. (A) Amounts 
transferred in trust before May 27, 1969 include amounts transferred in 
trust after May 26, 1969 when the transfer is made under the terms of a 
testamentary trust created by the will of a decedent who died before May 
27, 1969, (regardless of whether the executors or the testamentary 
trustees are required to execute testamentary trusts by court order 
under applicable local law). Amounts transferred in trust before May 27, 
1969, also include amounts transferred to a testamentary trust created 
by the will of a decedent who died after May 26, 1969 if the will was 
executed before May 27, 1969 and no dispositive provision of the will 
was amended (within the meaning of Sec. 20.2055-2(e)(4) and (5)) by the 
decedent by codicil or otherwise, after May 26, 1969, and the decedent 
was on May 27, 1969, and at all times thereafter under a mental 
disability (as defined in Sec. 1.642(c)-2(b)(3)(ii)) to amend the will 
by codicil or otherwise.
    (B) The provisions of this (iii) may be illustrated by the following 
example:

    Example. X executed a will in 1960 which provided for the creation 
of a testamentary trust which meets the description of a split-interest 
trust under section 4947(a)(2). X died on April 15, 1969. Under the 
provisions of his will, the probate court permitted certain property in 
X's estate to be transferred to the testamentary trust at fixed 
intervals over a period of two years during the administration of the 
estate. Section 4947(a)(2) does not apply to any amount described in 
this example, including the amounts transferred after May 26, 1969, 
because, for purposes of section 4947(a)(2)(C), each such transfer will 
be treated as an amount transferred in trust

[[Page 203]]

before May 27, 1969, within the meaning of section 4947(a)(2)(C).

    (6) Scope of application of section 4947(a)(2)--(i) In general. 
Subject to paragraph (c)(6) (ii), (iii), and (iv) of this section, 
section 4947(a)(2) applies to trusts in which some but not all unexpired 
interests are charitable. An estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
or free of trust to both charitable and noncharitable beneficiaries will 
not be considered to be a split-interest trust under section 4947(a)(2) 
during the period of estate administration or settlement, except as 
provided in paragraph (c)(6)(ii) of this section. A split-interest trust 
created by will shall be considered a split-interest trust under section 
4947(a)(2) as of the date of death of the decedent-grantor, except as 
provided in paragraph (c)(6)(iv) of this section.
    (ii) Estates. (A) When an estate from which the executor or 
administrator is required to distribute all of the net assets in trust 
or free of trust to both charitable and noncharitable beneficiaries is 
considered terminated for Federal income tax purposes under Sec. 
1.641(b)-3(a), then the estate will be treated as a split-interest trust 
under section 4947(a)(2) (or a charitable trust under section 
4957(a)(1), if applicable) between the date on which the estate is 
considered terminated under Sec. 1.641(b)-3(a) and the date on which 
final distribution of the net assets to the last remaining charitable 
beneficiary is made. This (ii) does not affect the determination of the 
tax liability under subtitle A of either charitable or noncharitable 
beneficiaries of the estates.
    (B) The provisions of this (ii) may be illustrated by the following 
example:

    Example. X dies on January 15, 1973 and bequeaths $10,000 to M, an 
organization described in section 501(c)(3), and the residue of his 
estate to W, his wife. A deduction for the charitable bequest was 
allowed to X's estate under section 2055. Substantially all of X's 
estate consists of 100 percent of the stock of a wholly owned 
corporation, certain liquid assets such as marketable stocks and 
securities and bank accounts, and X's home, automobile, and other 
personal property. X's will gives his executor a full range of powers, 
including the power to sell the stock of the wholly owned corporation. 
After the death of X, his executor continues to manage the wholly owned 
corporation while attempting to sell the stock of the corporation. 
During this period, the executor makes no distributions to M. On May 24, 
1978, the Internal Revenue Service determines under Sec. 1.641(b)-3(a) 
that the administration of the estate has been unduly prolonged and the 
estate is considered terminated as of that date for Federal income tax 
purposes. X's estate will be treated as a split-interest trust described 
in section 4947(a)(2) between May 24, 1978 and the date on which the 
$10,000 bequest to M is satisfied. X's estate will therefore be subject 
to the applicable private foundation provisions during that period and, 
for example, a sale of the house by the estate to any disqualified 
person (as defined in section 4946) will be an act of self-dealing under 
section 4941.

    (iii) Revocable trusts which become split-interest trusts. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor under the terms of the governing instrument of which the trustee 
is required to hold some or all of its net assets in trust after 
becoming irrevocable for both charitable and noncharitable beneficiaries 
is not considered a split-interest trust under section 4947(a)(2) for a 
reasonable period of settlement after becoming irrevocable except that 
section 4941 may apply if the requirements of Sec. 53.4941(d)-1(b)(3) 
are not met.

After that period, the trust is considered a split-interest trust under 
section 4947(a)(2). For purposes of this (iii), the term reasonable 
period of settlement means that period reasonably required (or if 
shorter, actually required) by the trustee to perform the ordinary 
duties of administration necessary for the settlement of the trust. 
These duties include, for example, the collection of assets, the payment 
of debts, taxes, and distributions, and the determination of rights of 
the subsequent beneficiaries.
    (iv) Certain revocable and testamentary trusts which wind up. A 
revocable trust that becomes irrevocable upon the death of the decedent-
grantor, or a trust created by will, from which the trustee is required 
to distribute all of the net assets in trust or free of trust to both 
charitable and noncharitable beneficiaries is not considered a split-
interest trust under section 4947(a)(2) for a reasonable period of 
settlement (within the meaning of paragraph (c)(6)(iii) of this section) 
after becoming irrevocable. After that period, the

[[Page 204]]

trust is considered a split-interest trust under section 4947(a)(2) (or 
a charitable trust under section 4947(a)(1), if applicable).
    (d) Cross references; Governing instrument requirements and 
charitable deduction limitations. For the application of section 
642(c)(6) (relating to section 170 limitations on charitable deductions 
of non-exempt private foundation trusts) to a trust described in section 
4947(a)(1), see Sec. 1.642(c)-4. For the denial of a deduction under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 for 
a gift, a bequest, or an amount paid to (and the denial of a deduction 
under section 642(c) for an amount set aside in) a trust described in 
section 4947(a)(1) or (2) that fails to meet the applicable governing 
instrument requirements of section 508(e) by the end of the taxable year 
of the trust, see section 508(d)(2) and Sec. 1.508-2(b). Since a 
charitable remainder trust (as defined in section 664) is not exempt 
under section 501(a), it is subject to section 4947(a)(2), and thus to 
the governing instrument requirements of section 508(e) to the extent 
they are applicable.
    (e) Application of section 507(a)--(1) General rule. The provisions 
of section 507(a) shall not apply to a trust described in section 
4947(a) (1) or (2) by reason of any payment to a beneficiary that is 
directed by the terms of the governing instrument of the trust and is 
not discretionary with the trustee or, in the case of a discretionary 
payment, by reason of, or following, the expiration of the last 
remaining charitable interest in the trust.
    (2) Examples. The provisions of this (e) may be illustrated by the 
following examples:

    Example 1. H creates a section 4947(a)(1) trust under which the 
income is to be paid for 15 years to R, a section 501(c)(3) 
organization. Upon the expiration of 15 years, the trust is to terminate 
and distribute all of its assets to S, another section 501(c)(3) 
organization. Distribution of the corpus of the trust to S will not be 
considered a termination of the trust's private foundation status within 
the meaning of section 507(a).
    Example 2. H creates a trust under which X, a section 501(c)(3) 
organization, receives $20,000 per year for a period of 20 years, 
remainder to S, H's son. H is allowed a deduction under section 2522 for 
the present value of X's interest.
    When the final payment to X has been made at the end of the 20-year 
period in accordance with the terms of the trust, the provisions of 
section 4947(a)(2) will cease to apply to the trust because the trust no 
longer retains any amounts for which the deduction under section 2522 
was allowed. However, the final payment to X will not be considered a 
termination of the trust's private foundation status within the meaning 
of section 507(a).
    Example 3. J creates a charitable remainder annuity trust described 
in section 664(d)(1) under which S, J's son, receives $10,000 per year 
for life, remainder to be distributed outright to P, an organization 
described in section 501(c)(3). J is allowed a deduction under section 
170 for the value of the remainder interest placed in trust for the 
benefit of P, and the provisions of section 4947(a)(2) apply to the 
trust. At the death of S, the trust will terminate and all assets will 
be distributed to P. However, such final distribution to P will not be 
considered a termination of the trust's private foundation status within 
the meaning of section 507(a).

[T.D. 7431, 41 FR 35515, Aug. 23, 1976]



Sec. 53.4947-2  Special rules.

    (a) Limit to segregated amounts. If any amounts held in trust are 
segregated within the meaning of Sec. 53.4947-1(c)(3), the value of the 
net assets for purposes of section 507(c)(2) and (g) shall be limited to 
the segregated amounts with respect to which a deduction under section 
170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522 was 
allowed. See the regulations under section 507(c)(2) and (g).
    (b) Applicability of section 4943 and 4944 to split-interests 
trusts--(1) General rule. Under section 4947(b)(3), section 4943 and 
4944 do not apply to a split-interest trust described in section 
4947(a)(2) if:
    (i) All the income interest (and none of the remainder interest) of 
the trust is devoted solely to one or more of the purposes described in 
section 170(c)(2)(B) and all amounts in the trust for which a deduction 
was allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522 have an aggregate value (at the time for which the 
deduction was allowed) of not more than 60 percent of the aggregate fair 
market value of all amounts in the trust (after the payment of estate 
taxes and all other liabilities), or

[[Page 205]]

    (ii) A deduction was allowed under section 170, 545(b)(2), 
556(b)(2), 642(c), 2055, 2106(a)(2) or 2522 for amounts payable under 
the terms of the trust to every remainder beneficiary, but not to any 
income beneficiary.

This (1) shall apply to a trust described in paragraph (b)(1)(ii) of 
this section only if all amounts payable under the terms of the trust to 
every remainder beneficiary are to be devoted solely to one or more of 
the purposes described in section 170(c)(2)(B). After the expiration of 
all income interests in a trust described in paragraph (b)(1)(ii) of 
this section, the trust shall become subject to section 4947(a)(1) under 
Sec. 53.4947-1(b)(2), and section 4947(b)(3) shall no longer apply to 
the trust. A pooled income fund described in section 642(c)(5) will 
generally meet the requirements of paragraph (b)(1)(ii) of this section, 
as will a charitable remainder trust described in section 664(d)(1), if 
in either case it does not make payments to any income beneficiary 
described in section 170(c).
    (2) Definitions. (i) For purposes of section 4947(b)(3)(A), the term 
``income interest'' shall include an interest in property transferred in 
trust which is in the form of a guaranteed annuity interest or unitrust 
interest as described in Sec. 1.170A-6(c), Sec. 20.2055-2(e)(2) or 
Sec. 25.2522(c)-3(c)(2) and the term ``remainder interest'' shall 
include an interest which succeeds an ``income interest'' within the 
meaning of this (i).
    (ii) For purposes of section 4947(b)(3)(B), the term ``income 
beneficiary'' shall include a recipient of payments described in section 
642(c)(5)(F) from a pooled income fund, payments described in section 
664(d)(1)(A) from a charitable remainder annuity trust, or payments 
described in section 664(d)(2)(A) or (3) from a charitable remainder 
unitrust. The term ``remainder beneficiary'' shall include a beneficiary 
of a remainder interest described in section 642(c)(5) or 664(d)(1)(C) 
or (2)(C).
    (c) Effective date. Except as otherwise provided in Sec. Sec. 
53.4947-1 and 53.4947-2 and the regulations under sections 508 (d) and 
(e), Sec. Sec. 53.4947-1 and 53.4947-2 shall take effect on January 1, 
1970.

(Secs. 4947 and 7805, Internal Revenue Code of 1954 (68A Stat. 917: 26 
U.S.C. 7805))

[T.D. 7431, 41 FR 35515, Aug. 23, 1976]



Subpart I_Tax on Investment Income of and Denial of Exemption to Certain 
                          Foreign Organizations



Sec. 53.4948-1  Application of taxes and denial of exemption with respect to 

certain foreign organizations.

    (a) Tax on income of certain foreign organizations. (1) In lieu of 
the tax imposed by section 4940 and the regulations thereunder, there is 
hereby imposed for each taxable year beginning after December 31, 1969, 
on the gross investment income (within the meaning of section 4940(c)(2) 
and the regulations thereunder) derived from sources within the United 
States (within the meaning of section 861 and the regulations 
thereunder) by every foreign organization which is a private foundation 
(within the meaning of section 509 and the regulations thereunder) and 
exempt from taxation under section 501(a) for the taxable year a tax 
equal to 4 percent of such income, except as provided in subparagraph 
(3) of this paragraph. The tax (if any) will be reported on the form the 
foundation is required to file under section 6033 and will be paid 
annually for the taxable year, at the time prescribed for filing such 
annual return (determined without regard to any extension of time for 
filing). For purposes of this section, the term foreign organization 
means any organization which is not described in section 170(o)(2)(A).
    (2) With respect to the deduction and withholding of tax imposed by 
section 4948(a), see section 1443(b) and the regulations thereunder.
    (3) Whenever there exists a tax treaty between the United States and 
a foreign country, and a foreign private foundation subject to section 
4948(a) is a resident of such country or is otherwise entitled to the 
benefits of such treaty (whether or not such benefits are available to 
all residents), if the treaty provides that any item or items

[[Page 206]]

(or all items with respect to an organization exempt from income 
taxation) of gross investment income (within the meaning of section 
4940(c)(2)) shall be exempt from income tax, such item or items shall 
not be taken into account by such foundation in computing the tax to be 
imposed under section 4948(a) for any taxable year for which the treaty 
is effective.
    (b) Certain sections inapplicable. Section 507 (relating to 
termination of private foundation status), section 508 (relating to 
special rules with respect to section 501(c)(3) organizations), and 
Chapter 42 (other than section 4948) of the Code shall not apply to any 
foreign organization which from the date of its creation has received at 
least 85 percent of its support (as defined in section 509(d), other 
than section 509(d)(4)) from sources outside the United States. For 
purposes of this paragraph, gifts, grants, contributions, or membership 
fees directly or indirectly from a United States person (as defined in 
section 7701(a)(30)) are from sources within the United States.
    (c) Denial of exemption to foreign organizations engaged in 
prohibited transactions--(1) In general. A foreign private foundation 
described in section 4948(b) and paragraph (b) of this section shall not 
be exempt from taxation under section 501(a) if it has engaged in a 
prohibited transaction (within the meaning of subparagraph (2) of this 
paragraph) after December 31, 1969.
    (2) Prohibited transactions. (i) For purposes of this section, the 
term ``prohibited transaction'' means any act or failure to act (other 
than with respect to section 4942(e), relating to minimum investment 
return) which would subject a foreign private foundation described in 
paragraph (b) of this section, or a disqualified person (as defined in 
section 4946) with respect thereto, to liability for a penalty under 
section 6684 (relating to assessable penalties with respect to liability 
for tax under Chapter 42) or a tax under section 507 (relating to 
termination of private foundation status) if such foreign private 
foundation were a domestic private foundation.
    (ii) For purposes of subdivision (i) of this subparagraph:
    (a) Approval by an appropriate foreign government of grants by the 
foreign private foundation to individuals is sufficient to satisfy the 
requirements of section 4945(g) and the regulations thereunder.
    (b) In determining whether a grantee of the foreign organization is 
a private foundation which is not an operating foundation for purposes 
of section 4942(g)(1)(A)(ii) or is an organization which is not 
described in section 509(a) (1), (2), or (3) for purposes of section 
4945 (d)(4) and (h), a determination made by such foreign organization 
will be accepted if such determination is made in good faith after a 
reasonable effort to identify the status of its grantee.
    (iii) For purposes of subdivision (i) of this subparagraph, in order 
for an act or failure to act (without regard to section 4942(e)) to be 
treated as a prohibited transaction under section 4948(c)(2) by reason 
of the application of section 6684(1), there must have been a prior act 
or failure to act (without regard to section 4942(e)), which:
    (a) Would have resulted in liability for tax under Chapter 42 (other 
than section 4940 or 4948(a)) if the foreign private foundation had been 
a domestic private foundation, and
    (b) Had been the subject of a warning from the Commissioner that a 
second act or failure to act (without regard to section 4942(e)) would 
result in a prohibited transaction.

The second act or failure to act (with respect to which a warning 
described in subparagraph (3)(i) of this paragraph is given) need not be 
related to the prior act or failure to act with respect to which a 
warning from the Commissioner was given under (b) of this subdivision.
    (3) Taxable years affected. (i) Except as provided in subdivision 
(ii) of this subparagraph, a foreign private foundation described in 
paragraph (b) of this section shall be denied exemption from taxation 
under section 501(a) by reason of subparagraph (1) of this paragraph for 
all taxable years beginning with the taxable year during which it is 
notified by the Commissioner that it has engaged in a prohibited 
transaction. The Commissioner shall publish such notice in the Federal 
Register on the day on

[[Page 207]]

which he so notifies such foreign private foundation. In the case of an 
act or failure to act (without regard to section 4942(e)) which would 
result in a penalty under section 6684(1) if the foreign private 
foundation were a domestic private foundation, before giving notice 
under this subdivision the Commissioner shall warn such foreign private 
foundation that such act or failure to act may be treated as a 
prohibited transaction. However, such act or failure to act will not be 
treated as a prohibited transaction if it is corrected (within the 
meaning of Chapter 42 and the regulations thereunder) within 90 days 
after the making of such warning.
    (ii)(a) Any foreign private foundation described in paragraph (b) of 
this section which is denied exemption from taxation under section 
501(a) by reason of subparagraph (1) of this paragraph may, with respect 
to the second taxable year following the taxable year in which notice is 
given under subdivision (i) of this subparagraph (or any taxable year 
subsequent to such second taxable year), file a request for exemption 
from taxation under section 501(a) on Form 1023. In addition to the 
information generally required of an organization requesting exemption 
as an organization described in section 501(a), a request under this 
subdivision must contain or have attached to it a written declaration, 
made under the penalties of perjury, by a principal officer of such 
organization authorized to make such declaration, that the organization 
will not knowingly again engage in a prohibited transaction.
    (b) If the Commissioner is satisfied that such organization will not 
knowingly again engage in a prohibited transaction and that the 
organization has satisfied all other requirements under section 501, the 
organization will be so notified in writing. In such case the 
organization shall not, with respect to taxable years beginning with the 
taxable year with respect to which a request under this subdivision is 
filed, be denied exemption from taxation under section 501(a) by reason 
of any prohibited transaction which was engaged in before the date on 
which notice was given under subdivision (i) of this subparagraph. 
Section 4948(c) provides that an organization denied exemption under 
such section will not be exempt from taxation under section 501(a) for 
the taxable year in which notice of loss of exemption is given and at 
least one immediately subsequent taxable year.
    (d) Disallowance of certain charitable deductions. No gift, bequest, 
legacy, devise, or transfer shall be allowed as a deduction under 
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522, if 
made:
    (1) To a foreign private foundation described in paragraph (b) of 
this section after the date on which the Commissioner publishes notice 
under paragraph (c)(3)(i) of this section that he has notified such 
organization that it has engaged in a prohibited transaction, and
    (2) In a taxable year of such organization for which it is not 
exempt from taxation under section 501(a) by reason of paragraph (c)(1) 
of this section.

For purposes of this paragraph, a bequest, legacy, devise, or transfer 
under section 2055 or 2106(a)(2) shall be treated as made on the date of 
death of the decedent. For example, assume that an individual gives 
money to a foreign private foundation described in section 4948(b) in 
January 1970, January 1971, and January 1972. The organization has a 
taxable year from June 1 through May 31. In February 1970, notice is 
duly published that the foreign organization has engaged in a prohibited 
transaction. In December 1970, the organization duly submits a request 
for exemption under paragraph (c)(3)(ii)(a) of this section which is 
granted for the taxable year ending May 31, 1972. The January 1970 gift 
is allowable as a deduction under section 2522 since it was made before 
the notice (February 1970). The January 1971 gift is not allowable as a 
deduction because the taxable year ending May 31, 1971, is a nonexempt 
year (the first taxable year subsequent to the taxable year of the 
notice) for the foreign organization. The January 1972 gift is allowable 
as a deduction under section 2522 because the taxable year ending May 
31, 1972, is an exempt year for the organization.

[T.D. 7218, 37 FR 23918, Nov. 10, 1972; 37 FR 24748, Nov. 21, 1972; 38 
FR 4324, Feb. 13, 1973]

[[Page 208]]



             Subpart J_Black Lung Benefit Trust Excise Taxes

    Source: T.D. 7644, 44 FR 52198, Sept. 7, 1979, unless otherwise 
noted.



Sec. 53.4951-1  Black lung trusts--taxes on self-dealing.

    (a) In general. Section 4951 contains provisions that correspond to 
provisions of section 4941 (relating to taxes on foundation self-
dealing) and section 4946 (relating to definitions and special rules). 
Regulations and rulings under these corresponding provisions apply to 
section 4951 where appropriate.
    (b) Transfer of property to trust. A transfer of personal property 
without consideration to a trust for which a deduction is allowable 
under section 192 does not constitute a sale or exchange for purposes of 
section 4951 unless the property is subject to a mortgage or similar 
lien within section 4951(d)(2)(A). The transfer to a trust of a note or 
other evidence of indebtedness constitutes an extension of credit to the 
obligor for purposes of section 4951(d)(1)(B).
    (c) Deposits. A time or demand deposit made with a bank or credit 
union that is a trustee or other disqualified person with respect to a 
trust constitutes a lending of money for purposes of section 
4951(d)(1)(B) even though the deposit is of a kind generally authorized 
for investments by the trust.
    (d) Trustee. The term ``trustee'' as used in section 4951(e)(5)(B) 
includes any person having powers or responsibilities with respect to a 
trust similar to those of trustees.
    (e) Misallocation of insurance premium. Under section 
501(c)(21)(A)(ii) and Sec. 1.501(c)(21)-1(d), a trust may pay a portion 
of a premium for insurance which covers both black lung liabilities and 
other liabilities, so long as the requirements of section 
501(c)(21)(A)(i) concerning allocation of the total premium are met. 
However, if an insurance company misallocates the total premium in a 
manner which benefits a disqualified person, the amount of misallocation 
constitutes a use of trust assets for the benefit of the disqualified 
person within section 4951(d)(1)(D). For these purposes, it is 
irrelevant whether the combination of insurance is sold under one policy 
or more than one policy.
    (f) Effective date. Section 4951 applies with respect to acts that 
occur after December 31, 1977, in and for trust taxable years beginning 
after December 31, 1977.



Sec. 53.4952-1  Black lung trusts--taxes on taxable expenditures.

    (a) In general. Section 4952 contains provisions that generally 
correspond to provisions of section 4945 (relating to taxes on taxable 
expenditures by private foundations) and section 4946 (relating to 
definitions and special rules). Regulations and rulings under these 
corresponding provisions apply to section 4952 where appropriate. See 
section 4952(e)(1) for the definition of correction.
    (b) Unauthorized investments. The term ``taxable expenditure'' in 
section 4952(d) includes an investment that is not authorized under 
section 501(c)(21)(B)(ii).
    (c) Effective date. Section 4952 applies with respect to 
expenditures made after December 31, 1977, in and for trust taxable 
years beginning after December 31, 1977.



                   Subpart K_Second Tier Excise Taxes

    Source: T.D. 8084, 51 FR 16303, May 2, 1986, unless otherwise noted.



Sec. 53.4955-1  Tax on political expenditures.

    (a) Relationship between section 4955 excise taxes and substantive 
standards for exemption under section 501(c)(3). The excise taxes 
imposed by section 4955 do not affect the substantive standards for tax 
exemption under section 501(c)(3), under which an organization is 
described in section 501(c)(3) only if it does not participate or 
intervene in any political campaign on behalf of any candidate for 
public office.
    (b) Imposition of initial taxes on organization managers--(1) In 
general. The excise tax under section 4955(a)(2) on the agreement of any 
organization manager to the making of a political expenditure by a 
section 501(c)(3) organization is imposed only in cases where--

[[Page 209]]

    (i) A tax is imposed by section 4955(a)(1);
    (ii) The organization manager knows that the expenditure to which 
the manager agrees is a political expenditure; and
    (iii) The agreement is willful and is not due to reasonable cause.
    (2) Type of organization managers covered--(i) In general. The tax 
under section 4955(a)(2) is imposed only on those organization managers 
who are authorized to approve, or to exercise discretion in recommending 
approval of, the making of the expenditure by the organization and on 
those organization managers who are members of a group (such as the 
organization's board of directors or trustees) which is so authorized.
    (ii) Officer. For purposes of section 4955(f)(2)(A), a person is an 
officer of an organization if--
    (A) That person is specifically so designated under the certificate 
of incorporation, bylaws, or other constitutive documents of the 
foundation; or
    (B) That person regularly exercises general authority to make 
administrative or policy decisions on behalf of the organization. 
Independent contractors, acting in a capacity as attorneys, accountants, 
and investment managers and advisors, are not officers. With respect to 
any expenditure, any person described in this paragraph (b)(2)(ii)(B) 
who has authority merely to recommend particular administrative or 
policy decisions, but not to implement them without approval of a 
superior, is not an officer.
    (iii) Employee. For purposes of section 4955(f)(2)(B), an individual 
rendering services to an organization is an employee of the organization 
only if that individual is an employee within the meaning of section 
3121(d)(2). With respect to any expenditure, an employee (other than an 
officer, director, or trustee of the organization) is described in 
section 4955(f)(2)(B) only if he or she has final authority or 
responsibility (either officially or effectively) with respect to such 
expenditure.
    (3) Type of agreement required. An organization manager agrees to 
the making of a political expenditure if the manager manifests approval 
of the expenditure which is sufficient to constitute an exercise of the 
organization manager's authority to approve, or to exercise discretion 
in recommending approval of, the making of the expenditure by the 
organization. The manifestation of approval need not be the final or 
decisive approval on behalf of the organization.
    (4) Knowing--(i) General rule. For purposes of section 4955, an 
organization manager is considered to have agreed to an expenditure 
knowing that it is a political expenditure only if--
    (A) The manager has actual knowledge of sufficient facts so that, 
based solely upon these facts, the expenditure would be a political 
expenditure;
    (B) The manager is aware that such an expenditure under these 
circumstances may violate the provisions of federal tax law governing 
political expenditures; and
    (C) The manager negligently fails to make reasonable attempts to 
ascertain whether the expenditure is a political expenditure, or the 
manager is aware that it is a political expenditure.
    (ii) Amplification of general rule. For purposes of section 4955, 
knowing does not mean having reason to know. However, evidence tending 
to show that an organization manager has reason to know of a particular 
fact or particular rule is relevant in determining whether the manager 
had actual knowledge of the fact or rule. Thus, for example, evidence 
tending to show that an organization manager has reason to know of 
sufficient facts so that, based solely upon those facts, an expenditure 
would be a political expenditure is relevant in determining whether the 
manager has actual knowledge of the facts.
    (5) Willful. An organization manager's agreement to a political 
expenditure is willful if it is voluntary, conscious, and intentional. 
No motive to avoid the restrictions of the law or the incurrence of any 
tax is necessary to make an agreement willful. However, an organization 
manager's agreement to a political expenditure is not willful if the 
manager does not know that it is a political expenditure.
    (6) Due to reasonable cause. An organization manager's actions are 
due to

[[Page 210]]

reasonable cause if the manager has exercised his or her responsibility 
on behalf of the organization with ordinary business care and prudence.
    (7) Advice of counsel. An organization manager's agreement to an 
expenditure is ordinarily not considered knowing or willful and is 
ordinarily considered due to reasonable cause if the manager, after full 
disclosure of the factual situation to legal counsel (including house 
counsel), relies on the advice of counsel expressed in a reasoned 
written legal opinion that an expenditure is not a political expenditure 
under section 4955 (or that expenditures conforming to certain 
guidelines are not political expenditures). For this purpose, a written 
legal opinion is considered reasoned even if it reaches a conclusion 
which is subsequently determined to be incorrect, so long as the opinion 
addresses itself to the facts and applicable law. A written legal 
opinion is not considered reasoned if it does nothing more than recite 
the facts and express a conclusion. However, the absence of advice of 
counsel with respect to an expenditure does not, by itself, give rise to 
any inference that an organization manager agreed to the making of the 
expenditure knowingly, willfully, or without reasonable cause.
    (8) Cross reference. For provisions relating to the burden of proof 
in cases involving the issue of whether an organization manager has 
knowingly agreed to the making of a political expenditure, see section 
7454(b).
    (c) Amplification of political expenditure definition--(1) General 
rule. Any expenditure that would cause an organization that makes the 
expenditure to be classified as an action organization by reason of 
Sec. 1.501(c)(3)-1(c)(3)(iii) of this chapter is a political 
expenditure within the meaning of section 4955(d)(1).
    (2) Other political expenditures--(i) For purposes of section 
4955(d)(2), an organization is effectively controlled by a candidate or 
prospective candidate only if the individual has a continuing, 
substantial involvement in the day-to-day operations or management of 
the organization. An organization is not effectively controlled by a 
candidate or a prospective candidate merely because it is affiliated 
with the candidate, or merely because the candidate knows the directors, 
officers, or employees of the organization. The effectively controlled 
test is not met merely because the organization carries on its research, 
study, or other educational activities with respect to subject matter or 
issues in which the individual is interested or with which the 
individual is associated.
    (ii) For purposes of section 4955(d)(2), a determination of whether 
the primary purpose of an organization is promoting the candidacy or 
prospective candidacy of an individual for public office is made on the 
basis of all the facts and circumstances. The factors to be considered 
include whether the surveys, studies, materials, etc. prepared by the 
organization are made available only to the candidate or are made 
available to the general public; and whether the organization pays for 
speeches and travel expenses for only one individual, or for speeches or 
travel expenses of several persons. The fact that a candidate or 
prospective candidate utilizes studies, papers, materials, etc., 
prepared by the organization (such as in a speech by the candidate) is 
not to be considered as a factor indicating that the organization has a 
purpose of promoting the candidacy or prospective candidacy of that 
individual where such studies, papers, materials, etc. are not made 
available only to that individual.
    (iii) Expenditures for voter registration, voter turnout, or voter 
education constitute other expenses, treated as political expenditures 
by reason of section 4955(d)(2)(E), only if the expenditures violate the 
prohibition on political activity provided in section 501(c)(3).
    (d) Abatement, refund, or no assessment of initial tax. No initial 
(first-tier) tax will be imposed under section 4955(a), or the initial 
tax will be abated or refunded, if the organization or an organization 
manager establishes to the satisfaction of the IRS that--
    (1) The political expenditure was not willful and flagrant; and
    (2) The political expenditure was corrected.
    (e) Correction--(1) Recovery of Expenditure. For purposes of section 
4955(f)(3)

[[Page 211]]

and this section, correction of a political expenditure is accomplished 
by recovering part or all of the expenditure to the extent recovery is 
possible, and, where full recovery cannot be accomplished, by any 
additional corrective action which the Commissioner may prescribe. The 
organization making the political expenditure is not under any 
obligation to attempt to recover the expenditure by legal action if the 
action would in all probability not result in the satisfaction of 
execution on a judgment.
    (2) Establishing safeguards. Correction of a political expenditure 
must also involve the establishment of sufficient safeguards to prevent 
future political expenditures by the organization. The determination of 
whether safeguards are sufficient to prevent future political 
expenditures by the organization is made by the District Director.
    (f) Effective date. This section is effective December 5, 1995.

[T.D. 8628, 60 FR 62210, Dec. 5, 1995]



Sec. 53.4958-0  Table of contents.

    This section lists the major captions contained in Sec. Sec. 
53.4958-1 through 53.4958-8.

          Sec. 53.4958-1 Taxes on excess benefit transactions

(a) In general.
(b) Excess benefit defined.
(c) Taxes paid by disqualified person.
(1) Initial tax.
(2) Additional tax on disqualified person.
(i) In general.
(ii) Taxable period.
(iii) Abatement if correction during the correction period.
(d) Tax paid by organization managers.
(1) In general.
(2) Organization manager defined.
(i) In general.
(ii) Special rule for certain committee members.
(3) Participation.
(4) Knowing.
(i) In general.
(ii) Amplification of general rule.
(iii) Reliance on professional advice.
(iv) Satisfaction of rebuttable presumption of reasonableness.
(5) Willful.
(6) Due to reasonable cause.
(7) Limits on liability for management.
(8) Joint and several liability.
(9) Burden of proof.
(e) Date of occurrence.
(1) In general.
(2) Special rules.
(3) Statute of limitations rules.
(f) Effective date for imposition of taxes.
(1) In general.
(2) Existing binding contracts.

    Sec. 53.4958-2 Definition of applicable tax-exempt organization

(a) Organizations described in section 501(c)(3) or (4) and exempt from 
          tax under section 501(a).
(1) In general.
(2) Exceptions from definition of applicable tax-exempt organization.
(i) Private foundation.
(ii) Governmental unit or affiliate.
(3) Organizations described in section 501(c)(3).
(4) Organizations described in section 501(c)(4).
(5) Effect of non-recognition or revocation of exempt status.
(b) Special rules.
(1) Transition rule for lookback period.
(2) Certain foreign organizations.

            Sec. 53.4958-3 Definition of disqualified person

(a) In general.
(1) Scope of definition.
(2) Transition rule for lookback period.
(b) Statutory categories of disqualified persons.
(1) Family members.
(2) Thirty-five percent controlled entities.
(i) In general.
(ii) Combined voting power.
(iii) Constructive ownership rules.
(A) Stockholdings.
(B) Profits or beneficial interest.
(c) Persons having substantial influence.
(1) Voting members of the governing body.
(2) Presidents, chief executive officers, or chief operating officers.
(3) Treasurers and chief financial officers.
(4) Persons with a material financial interest in a provider-sponsored 
          organization.
(d) Persons deemed not to have substantial influence.
(1) Tax-exempt organizations described in section 501(c)(3).
(2) Certain section 501(c)(4) organizations.
(3) Employees receiving economic benefits of less than a specified 
          amount in a taxable year.
(e) Facts and circumstances govern in all other cases.
(1) In general.
(2) Facts and circumstances tending to show substantial influence.
(3) Facts and circumstances tending to show no substantial influence.
(f) Affiliated organizations.
(g) Examples.

               Sec. 53.4958-4 Excess benefit transaction

(a) Definition of excess benefit transaction.

[[Page 212]]

(1) In general.
(2) Economic benefit provided indirectly.
(i) In general.
(ii) Through a controlled entity.
(A) In general.
(B) Definition of control.
(1) In general.
(2) Constructive ownership.
(iii) Through an intermediary.
(iv) Examples.
(3) Exception for fixed payments made pursuant to an initial contract.
(i) In general.
(ii) Fixed payment.
(A) In general.
(B) Special rules.
(iii) Initial contract.
(iv) Substantial performance required.
(v) Treatment as a new contract.
(vi) Evaluation of non-fixed payments.
(vii) Examples.
(4) Certain economic benefits disregarded for purposes of section 4958.
(i) Nontaxable fringe benefits.
(ii) Expense reimbursement payments pursuant to accountable plans.
(iii) Certain economic benefits provided to a volunteer for the 
          organization.
(iv) Certain economic benefits provided to a member of, or donor to, the 
          organization.
(v) Economic benefits provided to a charitable beneficiary.
(vi) Certain economic benefits provided to a governmental unit.
(5) Exception for certain payments made pursuant to an exemption granted 
          by the Department of Labor under ERISA.
(b) Valuation standards.
(1) In general.
(i) Fair market value of property.
(ii) Reasonable compensation.
(A) In general.
(B) Items included in determining the value of compensation for purposes 
          of determining reasonableness under section 4958.
(C) Inclusion in compensation for reasonableness determination does not 
          govern income tax treatment.
(2) Timing of reasonableness determination.
(i) In general.
(ii) Treatment as a new contract.
(iii) Examples.
(c) Establishing intent to treat economic benefit as consideration for 
          the performance of services.
(1) In general.
(2) Nontaxable benefits.
(3) Contemporaneous substantiation.
(i) Reporting of benefit.
(A) In general.
(B) Failure to report due to reasonable cause.
(ii) Other written contemporaneous evidence.
(4) Examples.

Sec. 53.4958-5 Transaction in which the amount of the economic benefit 
    is determined in whole or in part by the revenues of one or more 
               activities of the organization. [Reserved]

  Sec. 53.4958-6 Rebuttable presumption that a transaction is not an 
                       excess benefit transaction.

(a) In general.
(b) Rebutting the presumption.
(c) Requirements for invoking rebuttable presumption.
(1) Approval by an authorized body.
(i) In general.
(ii) Individuals not included on authorized body.
(iii) Absence of conflict of interest.
(2) Appropriate data as to comparability.
(i) In general.
(ii) Special rule for compensation paid by small organizations.
(iii) Application of special rule for small organizations.
(iv) Examples.
(3) Documentation.
(d) No presumption with respect to non-fixed payments until amounts are 
          determined.
(1) In general.
(2) Special rule for certain non-fixed payments subject to a cap.
(e) No inference from absence of presumption.
(f) Period of reliance on rebuttable presumption.

                       Sec. 53.4958-7 Correction.

(a) In general.
(b) Form of correction.
(1) Cash or cash equivalents.
(2) Anti-abuse rule.
(3) Special rule relating to nonqualified deferred compensation.
(4) Return of specific property.
(i) In general.
(ii) Payment not equal to correction amount.
(iii) Disqualified person may not participate in decision.
(c) Correction amount.
(d) Correction where contract has been partially performed.
(e) Correction in the case of an applicable tax-exempt organization that 
          has ceased to exist, or is no longer tax-exempt.
(1) In general.
(2) Section 501(c)(3) organizations.
(3) Section 501(c)(4) organizations.
(f) Examples.

                     Sec. 53.4958-8 Special rules.

(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for church 
          tax inquiries and examinations.
(c) Other substantiation requirements.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]

[[Page 213]]



Sec. 53.4958-1  Taxes on excess benefit transactions.

    (a) In general. Section 4958 imposes excise taxes on each excess 
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4) 
between an applicable tax-exempt organization (as defined in section 
4958(e) and Sec. 53.4958-2) and a disqualified person (as defined in 
section 4958(f)(1) and Sec. 53.4958-3). A disqualified person who 
receives an excess benefit from an excess benefit transaction is liable 
for payment of a section 4958(a)(1) excise tax equal to 25 percent of 
the excess benefit. If an initial tax is imposed by section 4958(a)(1) 
on an excess benefit transaction and the transaction is not corrected 
(as defined in section 4958(f)(6) and Sec. 53.4958-7) within the 
taxable period (as defined in section 4958(f)(5) and paragraph 
(c)(2)(ii) of this section), then any disqualified person who received 
an excess benefit from the excess benefit transaction on which the 
initial tax was imposed is liable for an additional tax of 200 percent 
of the excess benefit. An organization manager (as defined in section 
4958(f)(2) and paragraph (d) of this section) who participates in an 
excess benefit transaction, knowing that it was such a transaction, is 
liable for payment of a section 4958(a)(2) excise tax equal to 10 
percent of the excess benefit, unless the participation was not willful 
and was due to reasonable cause. If an organization manager also 
receives an excess benefit from an excess benefit transaction, the 
manager may be liable for both taxes imposed by section 4958(a).
    (b) Excess benefit defined. An excess benefit is the amount by which 
the value of the economic benefit provided by an applicable tax-exempt 
organization directly or indirectly to or for the use of any 
disqualified person exceeds the value of the consideration (including 
the performance of services) received for providing such benefit.
    (c) Taxes paid by disqualified person--(1) Initial tax. Section 
4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on 
each excess benefit transaction. The section 4958(a)(1) tax shall be 
paid by any disqualified person who received an excess benefit from that 
excess benefit transaction. With respect to any excess benefit 
transaction, if more than one disqualified person is liable for the tax 
imposed by section 4958(a)(1), all such persons are jointly and 
severally liable for that tax.
    (2) Additional tax on disqualified person--(i) In general. Section 
4958(b) imposes a tax equal to 200 percent of the excess benefit in any 
case in which section 4958(a)(1) imposes a 25-percent tax on an excess 
benefit transaction and the transaction is not corrected (as defined in 
section 4958(f)(6) and Sec. 53.4958-7) within the taxable period (as 
defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section). 
If a disqualified person makes a payment of less than the full 
correction amount under the rules of Sec. 53.4958-7, the 200-percent 
tax is imposed only on the unpaid portion of the correction amount (as 
described in Sec. 53.4958-7(c)). The tax imposed by section 4958(b) is 
payable by any disqualified person who received an excess benefit from 
the excess benefit transaction on which the initial tax was imposed by 
section 4958(a)(1). With respect to any excess benefit transaction, if 
more than one disqualified person is liable for the tax imposed by 
section 4958(b), all such persons are jointly and severally liable for 
that tax.
    (ii) Taxable period. Taxable period means, with respect to any 
excess benefit transaction, the period beginning with the date on which 
the transaction occurs and ending on the earlier of--
    (A) The date of mailing a notice of deficiency under section 6212 
with respect to the section 4958(a)(1) tax; or
    (B) The date on which the tax imposed by section 4958(a)(1) is 
assessed.
    (iii) Abatement if correction during the correction period. For 
rules relating to abatement of taxes on excess benefit transactions that 
are corrected within the correction period, as defined in section 
4963(e), see sections 4961(a), 4962(a), and the regulations thereunder. 
The abatement rules of section 4961 specifically provide for a 90-day 
correction period after the date of mailing a notice of deficiency under 
section 6212 with respect to the section 4958(b) 200-percent tax. If the 
excess benefit is corrected during that correction period, the 200-
percent tax imposed shall not be assessed, and if assessed the 
assessment shall be abated, and if collected

[[Page 214]]

shall be credited or refunded as an overpayment. For special rules 
relating to abatement of the 25-percent tax, see section 4962.
    (d) Tax paid by organization managers--(1) In general. In any case 
in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a 
tax equal to 10 percent of the excess benefit on the participation of 
any organization manager who knowingly participated in the excess 
benefit transaction, unless such participation was not willful and was 
due to reasonable cause. Any organization manager who so participated in 
the excess benefit transaction must pay the tax.
    (2) Organization manager defined--(i) In general. An organization 
manager is, with respect to any applicable tax-exempt organization, any 
officer, director, or trustee of such organization, or any individual 
having powers or responsibilities similar to those of officers, 
directors, or trustees of the organization, regardless of title. A 
person is an officer of an organization if that person--
    (A) Is specifically so designated under the certificate of 
incorporation, by-laws, or other constitutive documents of the 
organization; or
    (B) Regularly exercises general authority to make administrative or 
policy decisions on behalf of the organization. A contractor who acts 
solely in a capacity as an attorney, accountant, or investment manager 
or advisor, is not an officer. For purposes of this paragraph 
(d)(2)(i)(B), any person who has authority merely to recommend 
particular administrative or policy decisions, but not to implement them 
without approval of a superior, is not an officer.
    (ii) Special rule for certain committee members. An individual who 
is not an officer, director, or trustee, yet serves on a committee of 
the governing body of an applicable tax-exempt organization (or as a 
designee of the governing body described in Sec. 53.4958-6(c)(1)) that 
is attempting to invoke the rebuttable presumption of reasonableness 
described in Sec. 53.4958-6 based on the committee's (or designee's) 
actions, is an organization manager for purposes of the tax imposed by 
section 4958(a)(2).
    (3) Participation. For purposes of section 4958(a)(2) and this 
paragraph (d), participation includes silence or inaction on the part of 
an organization manager where the manager is under a duty to speak or 
act, as well as any affirmative action by such manager. An organization 
manager is not considered to have participated in an excess benefit 
transaction, however, where the manager has opposed the transaction in a 
manner consistent with the fulfillment of the manager's responsibilities 
to the applicable tax-exempt organization.
    (4) Knowing--(i) In general. For purposes of section 4958(a)(2) and 
this paragraph (d), a manager participates in a transaction knowingly 
only if the person--
    (A) Has actual knowledge of sufficient facts so that, based solely 
upon those facts, such transaction would be an excess benefit 
transaction;
    (B) Is aware that such a transaction under these circumstances may 
violate the provisions of Federal tax law governing excess benefit 
transactions; and
    (C) Negligently fails to make reasonable attempts to ascertain 
whether the transaction is an excess benefit transaction, or the manager 
is in fact aware that it is such a transaction.
    (ii) Amplification of general rule. Knowing does not mean having 
reason to know. However, evidence tending to show that a manager has 
reason to know of a particular fact or particular rule is relevant in 
determining whether the manager had actual knowledge of such a fact or 
rule. Thus, for example, evidence tending to show that a manager has 
reason to know of sufficient facts so that, based solely upon such 
facts, a transaction would be an excess benefit transaction is relevant 
in determining whether the manager has actual knowledge of such facts.
    (iii) Reliance on professional advice. An organization manager's 
participation in a transaction is ordinarily not considered knowing 
within the meaning of section 4958(a)(2), even though the transaction is 
subsequently held to be an excess benefit transaction, to the extent 
that, after full disclosure of the factual situation to an appropriate 
professional, the organization manager relies on a reasoned written 
opinion of

[[Page 215]]

that professional with respect to elements of the transaction within the 
professional's expertise. For purposes of section 4958(a)(2) and this 
paragraph (d), a written opinion is reasoned even though it reaches a 
conclusion that is subsequently determined to be incorrect so long as 
the opinion addresses itself to the facts and the applicable standards. 
However, a written opinion is not reasoned if it does nothing more than 
recite the facts and express a conclusion. The absence of a written 
opinion of an appropriate professional with respect to a transaction 
shall not, by itself, however, give rise to any inference that an 
organization manager participated in the transaction knowingly. For 
purposes of this paragraph, appropriate professionals on whose written 
opinion an organization manager may rely, are limited to--
    (A) Legal counsel, including in-house counsel;
    (B) Certified public accountants or accounting firms with expertise 
regarding the relevant tax law matters; and
    (C) Independent valuation experts who--
    (1) Hold themselves out to the public as appraisers or compensation 
consultants;
    (2) Perform the relevant valuations on a regular basis;
    (3) Are qualified to make valuations of the type of property or 
services involved; and
    (4) Include in the written opinion a certification that the 
requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this section 
are met.
    (iv) Satisfaction of rebuttable presumption of reasonableness. An 
organization manager's participation in a transaction is ordinarily not 
considered knowing within the meaning of section 4958(a)(2), even though 
the transaction is subsequently held to be an excess benefit 
transaction, if the appropriate authorized body has met the requirements 
of Sec. 53.4958-6(a) with respect to the transaction.
    (5) Willful. For purposes of section 4958(a)(2) and this paragraph 
(d), participation by an organization manager is willful if it is 
voluntary, conscious, and intentional. No motive to avoid the 
restrictions of the law or the incurrence of any tax is necessary to 
make the participation willful. However, participation by an 
organization manager is not willful if the manager does not know that 
the transaction in which the manager is participating is an excess 
benefit transaction.
    (6) Due to reasonable cause. An organization manager's participation 
is due to reasonable cause if the manager has exercised responsibility 
on behalf of the organization with ordinary business care and prudence.
    (7) Limits on liability for management. The maximum aggregate amount 
of tax collectible under section 4958(a)(2) and this paragraph (d) from 
organization managers with respect to any one excess benefit transaction 
is $10,000.
    (8) Joint and several liability. In any case where more than one 
person is liable for a tax imposed by section 4958(a)(2), all such 
persons shall be jointly and severally liable for the taxes imposed 
under section 4958(a)(2) with respect to that excess benefit 
transaction.
    (9) Burden of proof. For provisions relating to the burden of proof 
in cases involving the issue of whether an organization manager has 
knowingly participated in an excess benefit transaction, see section 
7454(b) and Sec. 301.7454-2 of this chapter. In these cases, the 
Commissioner bears the burden of proof.
    (e) Date of occurrence--(1) In general. Except as otherwise 
provided, an excess benefit transaction occurs on the date on which the 
disqualified person receives the economic benefit for Federal income tax 
purposes. When a single contractual arrangement provides for a series of 
compensation or other payments to (or for the use of) a disqualified 
person over the course of the disqualified person's taxable year (or 
part of a taxable year), any excess benefit transaction with respect to 
these aggregate payments is deemed to occur on the last day of the 
taxable year (or if the payments continue for part of the year, the date 
of the last payment in the series).
    (2) Special rules. In the case of benefits provided pursuant to a 
qualified pension, profit-sharing, or stock bonus plan, the transaction 
occurs on the date the benefit is vested. In the case of a transfer of 
property that is subject

[[Page 216]]

to a substantial risk of forfeiture or in the case of rights to future 
compensation or property (including benefits under a nonqualified 
deferred compensation plan), the transaction occurs on the date the 
property, or the rights to future compensation or property, is not 
subject to a substantial risk of forfeiture. However, where the 
disqualified person elects to include an amount in gross income in the 
taxable year of transfer pursuant to section 83(b), the general rule of 
paragraph (e)(1) of this section applies to the property with respect to 
which the section 83(b) election is made. Any excess benefit transaction 
with respect to benefits under a deferred compensation plan which vest 
during any taxable year of the disqualified person is deemed to occur on 
the last day of such taxable year. For the rules governing the timing of 
the reasonableness determination for deferred, contingent, and certain 
other noncash compensation, see Sec. 53.4958-4(b)(2).
    (3) Statute of limitations rules. See sections 6501(e)(3) and (l) 
and the regulations thereunder for statute of limitations rules as they 
apply to section 4958 excise taxes.
    (f) Effective date for imposition of taxes--(1) In general. The 
section 4958 taxes imposed on excess benefit transactions or on 
participation in excess benefit transactions apply to transactions 
occurring on or after September 14, 1995.
    (2) Existing binding contracts. The section 4958 taxes do not apply 
to any transaction occurring pursuant to a written contract that was 
binding on September 13, 1995, and at all times thereafter before the 
transaction occurs. A written binding contract that is terminable or 
subject to cancellation by the applicable tax-exempt organization 
without the disqualified person's consent (including as the result of a 
breach of contract by the disqualified person) and without substantial 
penalty to the organization, is no longer treated as a binding contract 
as of the earliest date that any such termination or cancellation, if 
made, would be effective. If a binding written contract is materially 
changed, it is treated as a new contract entered into as of the date the 
material change is effective. A material change includes an extension or 
renewal of the contract (other than an extension or renewal that results 
from the person contracting with the applicable tax-exempt organization 
unilaterally exercising an option expressly granted by the contract), or 
a more than incidental change to any payment under the contract.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002]



Sec. 53.4958-2  Definition of applicable tax-exempt organization.

    (a) Organizations described in section 501(c)(3) or (4) and exempt 
from tax under section 501(a)--(1) In general. An applicable tax-exempt 
organization is any organization that, without regard to any excess 
benefit, would be described in section 501(c)(3) or (4) and exempt from 
tax under section 501(a). An applicable tax-exempt organization also 
includes any organization that was described in section 501(c)(3) or (4) 
and was exempt from tax under section 501(a) at any time during a five-
year period ending on the date of an excess benefit transaction (the 
lookback period).
    (2) Exceptions from definition of applicable tax-exempt 
organization--(i) Private foundation. A private foundation as defined in 
section 509(a) is not an applicable tax-exempt organization for section 
4958 purposes.
    (ii) Governmental unit or affiliate. A governmental unit or an 
affiliate of a governmental unit is not an applicable tax-exempt 
organization for section 4958 purposes if it is--
    (A) Exempt from (or not subject to) taxation without regard to 
section 501(a); or
    (B) Relieved from filing an annual return pursuant to the authority 
of Sec. 1.6033-2(g)(6).
    (3) Organizations described in section 501(c)(3). An organization is 
described in section 501(c)(3) for purposes of section 4958 only if the 
organization--
    (i) Provides the notice described in section 508; or
    (ii) Is described in section 501(c)(3) and specifically is excluded 
from the requirements of section 508 by that section.
    (4) Organizations described in section 501(c)(4). An organization is 
described

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in section 501(c)(4) for purposes of section 4958 only if the 
organization--
    (i) Has applied for and received recognition from the Internal 
Revenue Service as an organization described in section 501(c)(4); or
    (ii) Has filed an application for recognition under section 
501(c)(4) with the Internal Revenue Service, has filed an annual 
information return as a section 501(c)(4) organization under the 
Internal Revenue Code or regulations promulgated thereunder, or has 
otherwise held itself out as being described in section 501(c)(4) and 
exempt from tax under section 501(a).
    (5) Effect of non-recognition or revocation of exempt status. An 
organization is not described in paragraph (a)(3) or (4) of this section 
during any period covered by a final determination or adjudication that 
the organization is not exempt from tax under section 501(a) as an 
organization described in section 501(c)(3) or (4), so long as that 
determination or adjudication is not based upon participation in 
inurement or one or more excess benefit transactions. However, the 
organization may be an applicable tax-exempt organization for that 
period as a result of the five-year lookback period described in 
paragraph (a)(1) of this section.
    (6) Examples. The following examples illustrate the principles of 
this section, which defines an applicable tax-exempt organization for 
purposes of section 4958:

    Example 1. O is a nonprofit corporation formed under state law. O 
filed its application for recognition of exemption under section 
501(c)(3) within the time prescribed under section 508(a). In its 
application, O described its plans for purchasing property from some of 
its directors at prices that would exceed fair market value. After 
reviewing the application, the IRS determined that because of the 
proposed property purchase transactions, O failed to establish that it 
met the requirements for an organization described in section 501(c)(3). 
Accordingly, the IRS denied O's application. While O's application was 
pending, O engaged in the purchase transactions described in its 
application at prices that exceeded the fair market values of the 
properties. Although these transactions would constitute excess benefit 
transactions under section 4958, because the IRS never recognized O as 
an organization described in section 501(c)(3), O was never an 
applicable tax-exempt organization under section 4958. Therefore, these 
transactions are not subject to the excise taxes provided in section 
4958.
    Example 2. O is a nonprofit corporation formed under state law. O 
files its application for recognition of exemption under section 
501(c)(3) within the time prescribed under section 508(a). The IRS 
issues a favorable determination letter in Year 1 that recognizes O as 
an organization described in section 501(c)(3). Subsequently, in Year 5 
of O's operations, O engages in certain transactions that constitute 
excess benefit transactions under section 4958 and violate the 
proscription against inurement under section 501(c)(3) and Sec. 
1.501(c)(3)-1(c)(2). The IRS examines the Form 990, ``Return of 
Organization Exempt From Income Tax'', that O filed for Year 5. After 
considering all the relevant facts and circumstances in accordance with 
Sec. 1.501(c)(3)-1(f), the IRS concludes that O is no longer described 
in section 501(c)(3) effective in Year 5. The IRS does not examine the 
Forms 990 that O filed for its first four years of operations and, 
accordingly, does not revoke O's exempt status for those years. Although 
O's tax-exempt status is revoked effective in Year 5, under the lookback 
rules in paragraph (a)(1) of this section and Sec. 53.4958-3(a)(1) of 
this chapter, during the five-year period prior to the excess benefit 
transactions that occurred in Year 5, O was an applicable tax-exempt 
organization and O's directors were disqualified persons as to O. 
Therefore, the transactions between O and its directors during Year 5 
are subject to the applicable excise taxes provided in section 4958.

    (b) Special rules--(1) Transition rule for lookback period. In the 
case of any excess benefit transaction occurring before September 14, 
2000, the lookback period described in paragraph (a)(1) of this section 
begins on September 14, 1995, and ends on the date of the transaction.
    (2) Certain foreign organizations. A foreign organization, 
recognized by the Internal Revenue Service or by treaty, that receives 
substantially all of its support (other than gross investment income) 
from sources outside of the United States is not an organization 
described in section 501(c)(3) or (4) for purposes of section 4958.

[T.D. 8978, 67 FR 3083, Jan. 23, 2002, as amended by T.D. 9390, 73 FR 
16524, Mar. 28, 2008]



Sec. 53.4958-3  Definition of disqualified person.

    (a) In general--(1) Scope of definition. Section 4958(f)(1) defines 
disqualified person, with respect to any transaction,

[[Page 218]]

as any person who was in a position to exercise substantial influence 
over the affairs of an applicable tax-exempt organization at any time 
during the five-year period ending on the date of the transaction (the 
lookback period). Paragraph (b) of this section describes persons who 
are defined to be disqualified persons under the statute, including 
certain family members of an individual in a position to exercise 
substantial influence, and certain 35-percent controlled entities. 
Paragraph (c) of this section describes persons in a position to 
exercise substantial influence over the affairs of an applicable tax-
exempt organization by virtue of their powers and responsibilities or 
certain interests they hold. Paragraph (d) of this section describes 
persons deemed not to be in a position to exercise substantial 
influence. Whether any person who is not described in paragraph (b), (c) 
or (d) of this section is a disqualified person with respect to a 
transaction for purposes of section 4958 is based on all relevant facts 
and circumstances, as described in paragraph (e) of this section. 
Paragraph (f) of this section describes special rules for affiliated 
organizations. Examples in paragraph (g) of this section illustrate 
these categories of persons.
    (2) Transition rule for lookback period. In the case of any excess 
benefit transaction occurring before September 14, 2000, the lookback 
period described in paragraph (a)(1) of this section begins on September 
14, 1995, and ends on the date of the transaction.
    (b) Statutory categories of disqualified persons--(1) Family 
members. A person is a disqualified person with respect to any 
transaction with an applicable tax-exempt organization if the person is 
a member of the family of a person who is a disqualified person 
described in paragraph (a) of this section (other than as a result of 
this paragraph) with respect to any transaction with the same 
organization. For purposes of the following sentence, a legally adopted 
child of an individual is treated as a child of such individual by 
blood. A person's family is limited to--
    (i) Spouse;
    (ii) Brothers or sisters (by whole or half blood);
    (iii) Spouses of brothers or sisters (by whole or half blood);
    (iv) Ancestors;
    (v) Children;
    (vi) Grandchildren;
    (vii) Great grandchildren; and
    (viii) Spouses of children, grandchildren, and great grandchildren.
    (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; or
    (C) A trust or estate in which persons described in this section 
(except in paragraphs (b)(2) and (d) of this section) own more than 35 
percent of the beneficial interest.
    (ii) Combined voting power. For purposes of this paragraph (b)(2), 
combined voting power includes voting power represented by holdings of 
voting stock, direct or indirect, but does not include voting rights 
held only as a director, trustee, or other fiduciary.
    (iii) Constructive ownership rules--(A) Stockholdings. For purposes 
of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings 
are taken into account as under section 267(c), except that in applying 
section 267(c)(4), the family of an individual shall include the members 
of the family specified in section 4958(f)(4) and paragraph (b)(1) of 
this section.
    (B) Profits or beneficial interest. For purposes of section 
4958(f)(3) and this paragraph (b)(2), the ownership of profits or 
beneficial interests shall be determined in accordance with the rules 
for constructive ownership of stock provided in section 267(c) (other 
than section 267(c)(3)), except that in applying section 267(c)(4), the 
family of an individual shall include the members of the family 
specified in section 4958(f)(4) and paragraph (b)(1) of this section.

[[Page 219]]

    (c) Persons having substantial influence. A person who holds any of 
the following powers, responsibilities, or interests is in a position to 
exercise substantial influence over the affairs of an applicable tax-
exempt organization:
    (1) Voting members of the governing body. This category includes any 
individual serving on the governing body of the organization who is 
entitled to vote on any matter over which the governing body has 
authority.
    (2) Presidents, chief executive officers, or chief operating 
officers. This category includes any person who, regardless of title, 
has ultimate responsibility for implementing the decisions of the 
governing body or for supervising the management, administration, or 
operation of the organization. A person who serves as president, chief 
executive officer, or chief operating officer has this ultimate 
responsibility unless the person demonstrates otherwise. If this 
ultimate responsibility resides with two or more individuals (e.g., co-
presidents), who may exercise such responsibility in concert or 
individually, then each individual is in a position to exercise 
substantial influence over the affairs of the organization.
    (3) Treasurers and chief financial officers. This category includes 
any person who, regardless of title, has ultimate responsibility for 
managing the finances of the organization. A person who serves as 
treasurer or ch