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



[[Page i]]

          

          26


          Part 1 (Sec. Sec.  1.501 to 1.640)

                         Revised as of April 1, 2009


          Internal Revenue
          



________________________

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2009
          With Ancillaries
                    Published by
                    Office of the Federal Register
                    National Archives and Records
                    Administration
                    A Special Edition of the Federal Register

[[Page ii]]

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[[Page iii]]




                            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........................     581
      Alphabetical List of Agencies Appearing in the CFR......     601
      Table of OMB Control Numbers............................     611
      List of CFR Sections Affected...........................     629

[[Page iv]]





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

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 1.501(a)-1 
                       refers to title 26, part 
                       1, section 501(a)-1.

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

[[Page v]]



                               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 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, April 1, 2009), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

    Each volume of the Code contains amendments published in the Federal 
Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
number of the Federal Register and date of publication. Publication 
dates and effective dates are usually not the same and care must be 
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instances where the effective date is beyond the cut-off date for the 
Code a note has been inserted to reflect the future effective date. In 
those instances where a regulation published in the Federal Register 
states a date certain for expiration, an appropriate note will be 
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 
amendments to existing regulations in the CFR. These OMB numbers are 
placed as close as possible to the applicable recordkeeping or reporting 
requirements.

OBSOLETE PROVISIONS

    Provisions that become obsolete before the revision date stated on 
the cover of each volume are not carried. Code users may find the text 
of provisions in effect on a given date in the past by using the 
appropriate numerical list of sections affected. For the period before 
January 1, 2001, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, 1973-1985, or 1986-2000, published in eleven separate 
volumes. For the period beginning January 1, 2001, a ``List of CFR 
Sections Affected'' is published at the end of each CFR volume.

INCORPORATION BY REFERENCE

    What is incorporation by reference? Incorporation by reference was 
established by statute and allows Federal agencies to meet the 
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if it were published in full in the Federal Register (5 U.S.C. 552(a)). 
This material, like any other properly issued regulation, has the force 
of law.
    What is a proper incorporation by reference? The Director of the 
Federal Register will approve an incorporation by reference only when 
the requirements of 1 CFR part 51 are met. Some of the elements on which 
approval is based are:
    (a) The incorporation will substantially reduce the volume of 
material published in the Federal Register.
    (b) The matter incorporated is in fact available to the extent 
necessary to afford fairness and uniformity in the administrative 
process.
    (c) The incorporating document is drafted and submitted for 
publication in accordance with 1 CFR part 51.
    What if the material incorporated by reference cannot be found? If 
you have any problem locating or obtaining a copy of material listed as 
an approved incorporation by reference, please contact the agency that 
issued the regulation containing that incorporation. If, after 
contacting the agency, you find the material is not available, please 
notify the Director of the Federal Register, National Archives and 
Records Administration, Washington DC 20408, or call 202-741-6010.

CFR INDEXES AND TABULAR GUIDES

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separate volume, revised annually as of January 1, entitled CFR Index 
and Finding Aids. This volume contains the Parallel Table of Statutory 
Authorities and Agency Rules (Table I). A list of CFR titles, chapters, 
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also included in this volume.
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that volume.
    The Federal Register Index is issued monthly in cumulative form. 
This index is based on a consolidation of the ``Contents'' entries in 
the daily Federal Register.
    A List of CFR Sections Affected (LSA) is published monthly, keyed to 
the revision dates of the 50 CFR titles.




[[Page vii]]



REPUBLICATION OF MATERIAL

    There are no restrictions on the republication of material appearing 
in the Code of Federal Regulations.

INQUIRIES

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volume, contact the issuing agency. The issuing agency's name appears at 
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or write to the Director, Office of the Federal Register, National 
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ELECTRONIC SERVICES

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register. The NARA site also contains links to GPO Access.

    Raymond A. Mosley,
    Director,
    Office of the Federal Register.
    April 1, 2009.







[[Page ix]]



                               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, 
2009. 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, Jonn V. Lilyea 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 part 1, Sec. Sec. 1.501 to 1.640)

  --------------------------------------------------------------------
                                                                    Part

chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................           1

[[Page 3]]



    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 A--INCOME TAX (CONTINUED)
Part                                                                Page
1               Income taxes (continued)....................           5

Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

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

[[Page 5]]



                   SUBCHAPTER A_INCOME TAX (CONTINUED)



PART 1_INCOME TAXES (CONTINUED)--Table of Contents




                        Normal Taxes and Surtaxes

                          Exempt Organizations

                              General Rule

Sec.
1.501(a)-1 Exemption from taxation.
1.501(c)(2)-1 Corporations organized to hold title to property for 
          exempt organizations.
1.501(c)(3)-1 Organizations organized and operated for religious, 
          charitable, scientific, testing for public safety, literary, 
          or educational purposes, or for the prevention of cruelty to 
          children or animals.
1.501(c)(4)-1 Civic organizations and local associations of employees.
1.501(c)(5)-1 Labor, agricultural, and horticultural organizations.
1.501(c)(6)-1 Business leagues, chambers of commerce, real estate 
          boards, and boards of trade.
1.501(c)(7)-1 Social clubs.
1.501(c)(8)-1 Fraternal beneficiary societies.
1.501(c)(9)-1 Voluntary employees' beneficiary associations, in general.
1.501(c)(9)-2 Membership in a voluntary employees' beneficiary 
          association; employees; voluntary association of employees.
1.501(c)(9)-3 Voluntary employees' beneficiary associations; life, sick, 
          accident, or other benefits.
1.501(c)(9)-4 Voluntary employees' beneficiary associations; inurement.
1.501(c)(9)-5 Voluntary employees' beneficiary associations; 
          recordkeeping requirements.
1.501(c)(9)-6 Voluntary employees' beneficiary associations; benefits 
          includible in gross income.
1.501(c)(9)-7 Voluntary employees' beneficiary associations; section 
          3(4) of ERISA.
1.501(c)(9)-8 Voluntary employees' beneficiary associations; effective 
          date.
1.501(c)(10)-1 Certain fraternal beneficiary societies.
1.501(c)(12)-1 Local benevolent life insurance associations, mutual 
          irrigation and telephone companies, and like organizations.
1.501(c)(13)-1 Cemetery companies and crematoria.
1.501(c)(14)-1 Credit unions and mutual insurance funds.
1.501(c)(15)-1 Mutual insurance companies or associations.
1.501(c)(16)-1 Corporations organized to finance crop operations.
1.501(c)(17)-1 Supplemental unemployment benefit trusts.
1.501(c)(17)-2 General rules.
1.501(c)(17)-3 Relation to other sections of the Code.
1.501(c)(18)-1 Certain funded pension trusts.
1.501(c)(19)-1 War veterans organizations.
1.501(c)(21)-1 Black lung trusts--certain terms.
1.501(c)(21)-2 Same--trust instrument.
1.501(d)-1 Religious and apostolic associations or corporations.
1.501(e)-1 Cooperative hospital service organizations.
1.501(h)-1 Application of the expenditure test to expenditures to 
          influence legislation; introduction.
1.501(h)-2 Electing the expenditure test.
1.501(h)-3 Lobbying or grass roots expenditures normally in excess of 
          ceiling amount.
1.501(k)-1 Communist-controlled organizations.
1.502-1 Feeder organizations.
1.503(a)-1 Denial of exemption to certain organizations engaged in 
          prohibited transactions.
1.503(b)-1 Prohibited transactions.
1.503(c)-1 Future status of organizations denied exemption.
1.503(d)-1 Cross references.
1.503(e)-1 Special rules.
1.503(e)-2 Requirements.
1.503(e)-3 Effective dates.
1.503(e)-4 Disallowance of charitable deductions for certain gifts made 
          before January 1, 1970.
1.503(f)-1 Loans by employers who are prohibited from pledging assets.
1.504-1 Attempts to influence legislation; certain organizations 
          formerly described in section 501(c)(3) denied exemption.
1.504-2 Certain transfers made to avoid section 504(a).
1.505(c)-1T Questions and answers relating to the notification 
          requirement for recognition of exemption under paragraphs (9), 
          (17) and (20) of Section 501(c) (temporary).

                           Private Foundations

1.507-1 General rule.
1.507-2 Special rules; transfer to, or operation as, public charity.
1.507-2T Special rules; transfer to, or operation as, public charity 
          (temporary).
1.507-3 Special rules; transferee foundations.
1.507-4 Imposition of tax.
1.507-5 Aggregate tax benefit; in general.
1.507-6 Substantial contributor defined.
1.507-7 Value of assets.
1.507-8 Liability in case of transfers.

[[Page 6]]

1.507-9 Abatement of taxes.
1.508-1 Notices.
1.508-2 Disallowance of certain charitable, etc., deductions.
1.508-3 Governing instruments.
1.508-4 Effective date.
1.509(a)-1 Definition of private foundation.
1.509(a)-2 Exclusion for certain organizations described in section 
          170(b)(1)(A).
1.509(a)-3 Broadly, publicly supported organizations.
1.509(a)-3T Broadly, publicly supported organizations (temporary).
1.509(a)-4 Supporting organizations.
1.509(a)-5 Special rules of attribution.
1.509(a)-6 Classification under section 509(a).
1.509(a)-7 Reliance by grantors and contributors to section 509(a) (1), 
          (2), and (3) organizations.
1.509(b)-1 Continuation of private foundation status.
1.509(c)-1 Status of organization after termination of private 
          foundation status.
1.509(d)-1 Definition of support.
1.509(e)-1 Definition of gross investment income.

       Taxation of Business Income of Certain Exempt Organizations

1.511-1 Imposition and rates of tax.
1.511-2 Organizations subject to tax.
1.511-3 Provisions generally applicable to the tax on unrelated business 
          income.
1.511-4 Minimum tax for tax preferences.
1.512(a)-1 Definition.
1.512(a)-2 Definition applicable to taxable years beginning before 
          December 13, 1967.
1.512(a)-3 [Reserved]
1.512(a)-4 Special rules applicable to war veterans organizations.
1.512(a)-5T Questions and answers relating to the unrelated business 
          taxable income of organizations described in paragraphs (9), 
          (17) or (20) of Section 501(c) (temporary).
1.512(b)-1 Modifications.
1.512(c)-1 Special rules applicable to partnerships; in general.
1.513-1 Definition of unrelated trade or business.
1.513-2 Definition of unrelated trade or business applicable to taxable 
          years beginning before December 13, 1967.
1.513-3 Qualified convention and trade show activity.
1.513-4 Certain sponsorship not unrelated trade or business.
1.513-5 Certain bingo games not unrelated trade or business.
1.513-6 Certain hospital services not unrelated trade or business.
1.513-7 Travel and tour activities of tax exempt organizations.
1.514(a)-1 Unrelated debt-financed income and deductions.
1.514(a)-2 Business lease rents and deductions for taxable years 
          beginning before January 1, 1970.
1.514(b)-1 Definition of debt-financed property.
1.514(c)-1 Acquisition indebtedness.
1.514(c)-2 Permitted allocations under section 514(c)(9)(E).
1.514(d)-1 Basis of debt-financed property acquired in corporate 
          liquidation.
1.514(e)-1 Allocation rules.
1.514(f)-1 Definition of business lease.
1.514(g)-1 Business lease indebtedness.

                          Farmers' Cooperatives

1.521-1 Farmers' cooperative marketing and purchasing associations; 
          requirements for exemption under section 521.
1.522-1 Tax treatment of farmers' cooperative marketing and purchasing 
          associations exempt under section 521.
1.522-2 Manner of taxation of cooperative associations subject to 
          section 522.
1.522-3 Patronage dividends, rebates, or refunds; treatment as to 
          cooperative associations entitled to tax treatment under 
          section 522.
1.522-4 Taxable years affected.
1.527-1 Political organizations; generally.
1.527-2 Definitions.
1.527-3 Exempt function income.
1.527-4 Special rules for computation of political organization taxable 
          income.
1.527-5 Activities resulting in gross income to an individual or 
          political organization.
1.527-6 Inclusion of certain amounts in the gross income of an exempt 
          organization which is not a political organization.
1.527-7 Newsletter funds.
1.527-8 Effective date; filing requirements; and miscellaneous 
          provisions.
1.527-9 Special rule for principal campaign committees.

                         Homeowners Associations

1.528-1 Homeowners associations.
1.528-2 Organized and operated to provide for the acquisition, 
          construction, management, maintenance and care of association 
          property.
1.528-3 Association property.
1.528-4 Substantiality test.
1.528-5 Source of income test.
1.528-6 Expenditure test.
1.528-7 Inurement.
1.528-8 Election to be treated as a homeowners association.
1.528-9 Exempt function income.
1.528-10 Special rules for computation of homeowners association taxable 
          income and tax.

[[Page 7]]

          Corporations Used To Avoid Income Tax on Shareholders

              Corporations Improperly Accumulating Surplus

1.531-1 Imposition of tax.
1.532-1 Corporations subject to accumulated earnings tax.
1.533-1 Evidence of purpose to avoid income tax.
1.533-2 Statement required.
1.534-1 Burden of proof as to unreasonable accumulations generally.
1.534-2 Burden of proof as to unreasonable accumulations in cases before 
          the Tax Court.
1.534-3 Jeopardy assessments in Tax Court cases.
1.535-1 Definition.
1.535-2 Adjustments to taxable income.
1.535-3 Accumulated earnings credit.
1.536-1 Short taxable years.
1.537-1 Reasonable needs of the business.
1.537-2 Grounds for accumulation of earnings and profits.
1.537-3 Business of the corporation.

                       Personal Holding Companies

1.541-1 Imposition of tax.
1.542-1 General rule.
1.542-2 Gross income requirement.
1.542-3 Stock ownership requirement.
1.542-4 Corporations filing consolidated returns.
1.543-1 Personal holding company income.
1.543-2 Limitation on gross income and personal holding company income 
          in transactions involving stocks, securities, and commodities.
1.544-1 Constructive ownership.
1.544-2 Constructive ownership by reason of indirect ownership.
1.544-3 Constructive ownership by reason of family and partnership 
          ownership.
1.544-4 Options.
1.544-5 Convertible securities.
1.544-6 Constructive ownership as actual ownership.
1.544-7 Option rule in lieu of family and partnership rule.
1.545-1 Definition.
1.545-2 Adjustments to taxable income.
1.545-3 Special adjustment to taxable income.
1.547-1 General rule.
1.547-2 Requirements for deficiency dividends.
1.547-3 Claim for credit or refund.
1.547-4 Effect on dividends paid deduction.
1.547-5 Deduction denied in case of fraud or wilful failure to file 
          timely return.
1.547-6 Suspension of statute of limitations and stay of collection.
1.547-7 Effective date.

                   Foreign Personal Holding Companies

1.551-1 General rule.
1.551-2 Amount included in gross income.
1.551-3 Deduction for obligations of the United States and its 
          instrumentalities.
1.551-4 Information in return.
1.551-5 Effect on capital account of foreign personal holding company 
          and basis of stock in hands of shareholders.
1.552-1 Definition of foreign personal holding company.
1.552-2 Gross income requirement.
1.552-3 Stock ownership requirement.
1.552-4 Certain excluded banks.
1.552-5 United States shareholder of excluded bank.
1.553-1 Foreign personal holding company income.
1.554-1 Stock ownership.
1.555-1 General rule.
1.555-2 Additions to gross income.
1.556-1 Definition.
1.556-2 Adjustments to taxable income.
1.556-3 Illustration of computation of undistributed foreign personal 
          holding company income.

                      Deduction for Dividends Paid

1.561-1 Deduction for dividends paid.
1.561-2 When dividends are considered paid.
1.562-1 Dividends for which the dividends paid deduction is allowable.
1.562-2 Preferential dividends.
1.562-3 Distributions by a member of an affiliated group.
1.563-1 Accumulated earnings tax.
1.563-2 Personal holding company tax.
1.563-3 Dividends considered as paid on last day of taxable year.
1.564-1 Dividend carryover.
1.565-1 General rule.
1.565-2 Limitations.
1.565-3 Effect of consent.
1.565-4 Consent dividends and other distributions.
1.565-5 Nonresident aliens and foreign corporations.
1.565-6 Definitions.

                          Banking Institutions

          Rules of General Application to Banking Institutions

1.581-1 Banks.
1.581-2 Mutual savings banks, building and loan associations, and 
          cooperative banks.
1.581-3 Definition of bank prior to September 28, 1962.
1.582-1 Bad debts, losses, and gains with respect to securities held by 
          financial institutions.
1.584-1 Common trust funds.
1.584-2 Income of participants in common trust fund.
1.584-3 Computation of common trust fund income.
1.584-4 Admission and withdrawal of participants in the common trust 
          fund.

[[Page 8]]

1.584-5 Returns of banks with respect to common trust funds.
1.584-6 Net operating loss deduction.
1.585-1 Reserve for losses on loans of banks.
1.585-2 Addition to reserve.
1.585-3 Special rules.
1.585-4 Reorganizations and asset acquisitions.
1.585-5 Denial of bad debt reserves for large banks.
1.585-6 Recapture method of changing from the reserve method of section 
          585.
1.585-7 Elective cut-off method of changing from the reserve method of 
          section 585.
1.585-8 Rules for making and revoking elections under Sec. Sec. 1.585-6 
          and 1.585-7.
1.586-1 Reserve for losses on loans of small business investment 
          companies, etc.
1.586-2 Addition to reserve.

                       Mutual Savings Banks, Etc.

1.591-1 Deduction for dividends paid on deposits.
1.592-1 Repayment of certain loans by mutual savings banks, building and 
          loan associations, and cooperative banks.
1.593-1 Additions to reserve for bad debts.
1.593-2 Additions to reserve for bad debts where surplus, reserves, and 
          undivided profits equal or exceed 12 percent of deposits or 
          withdrawable accounts.
1.593-3 Taxable years affected.
1.593-4 Organizations to which section 593 applies.
1.593-5 Addition to reserves for bad debts.
1.593-6 Pre-1970 addition to reserve for losses on qualifying real 
          property loans.
1.593-6A Post-1969 addition to reserve for losses on qualifying real 
          property loans.
1.593-7 Establishment and treatment of reserves for bad debts.
1.593-8 Allocation of pre-1952 surplus to opening balance of reserve for 
          losses on qualifying real property loans.
1.593-10 Certain distributions to shareholders by a domestic building 
          and loan association.
1.593-11 Qualifying real property loan and nonqualifying loan defined.
1.594-1 Mutual savings banks conducting life insurance business.
1.595-1 Treatment of foreclosed property by certain creditors.
1.596-1 Limitation on dividends received deduction.
1.597-1 Definitions.
1.597-2 Taxation of Federal financial assistance.
1.597-3 Other rules.
1.597-4 Bridge Banks and Agency Control.
1.597-5 Taxable Transfers.
1.597-6 Limitation on collection of income tax.
1.597-7 Effective date.
1.597-8 Transitional rules for Federal financial assistance.

                             Bank Affiliates

1.601-1 Special deduction for bank affiliates.

                            Natural Resources

                               Deductions

1.611-0 Regulatory authority.
1.611-1 Allowance of deduction for depletion.
1.611-2 Rules applicable to mines, oil and gas wells, and other natural 
          deposits.
1.611-3 Rules applicable to timber.
1.611-4 Depletion as a factor in computing earnings and profits for 
          dividend purposes.
1.611-5 Depreciation of improvements.
1.612-1 Basis for allowance of cost depletion.
1.612-2 Allowable capital additions in case of mines.
1.612-3 Depletion; treatment of bonus and advanced royalty.
1.612-4 Charges to capital and to expense in case of oil and gas wells.
1.612-5 Charges to capital and to expense in case of geothermal wells.
1.613-1 Percentage depletion; general rule.
1.613-2 Percentage depletion rates.
1.613-3 Gross income from the property.
1.613-4 Gross income from the property in the case of minerals other 
          than oil and gas.
1.613-5 Taxable income from the property.
1.613-6 Statement to be attached to return when depletion is claimed on 
          percentage basis.
1.613-7 Application of percentage depletion rates provided in section 
          613(b) to certain taxable years ending in 1954.
1.613A-0 Limitations on percentage depletion in the case of oil and gas 
          wells; table of contents.
1.613A-1 Post-1974 limitations on percentage depletion in case of oil 
          and gas wells; general rule.
1.613A-2 Exemption for certain domestic gas wells.
1.613A-3 Exemption for independent producers and royalty owners.
1.613A-4 Limitations on application of Sec. 1.613A-3 exemption.
1.613A-5 Election under section 613A(c)(4).
1.613A-6 Recordkeeping requirements.
1.613A-7 Definitions.
1.614-0 Introduction.
1.614-1 Definition of property.
1.614-2 Election to aggregate separate operating mineral interests under 
          section 614(b) prior to its amendment by Revenue Act of 1964.
1.614-3 Rules relating to separate operating mineral interests in the 
          case of mines.
1.614-4 Treatment under the Internal Revenue Code of 1939 with respect 
          to separate operating mineral interests for taxable years 
          beginning before January 1, 1964, in the case of oil and gas 
          wells.

[[Page 9]]

1.614-5 Special rules as to aggregating nonoperating mineral interests.
1.614-6 Rules applicable to basis, holding period, and abandonment 
          losses where mineral interests have been aggregated or 
          combined.
1.614-7 Extension of time for performing certain acts.
1.614-8 Elections with respect to separate operating mineral interests 
          for taxable years beginning after December 31, 1963, in the 
          case of oil and gas wells.
1.615-1 Pre-1970 exploration expenditures.
1.615-2 Deduction of pre-1970 exploration expenditures in the year paid 
          or incurred.
1.615-3 Election to defer pre-1970 exploration expenditures.
1.615-4 Limitation of amount deductible.
1.615-5 Time for making election with respect to returns due on or 
          before May 2, 1960.
1.615-6 Election to deduct under section 615.
1.615-7 Effect of transfer of mineral property.
1.615-8 Termination of section 615.
1.615-9 Notification under Tax Reform Act of 1969.
1.616-1 Development expenditures.
1.616-2 Election to defer.
1.616-3 Time for making election with respect to returns due on or 
          before May 2, 1960.
1.617-1 Exploration expenditures.
1.617-2 Limitation on amount deductible.
1.617-3 Recapture of exploration expenditures.
1.617-4 Treatment of gain from disposition of certain mining property.

                      Exclusions From Gross Income

1.621-1 Payments to encourage exploration, development, and mining for 
          defense purposes.

                           Sales and Exchanges

1.631-1 Election to consider cutting as sale or exchange.
1.631-2 Gain or loss upon the disposal of timber under cutting contract.
1.631-3 Gain or loss upon the disposal of coal or domestic iron ore with 
          a retained economic interest.
1.632-1 Tax on sale of oil or gas properties.

                       Mineral Production Payments

1.636-1 Treatment of production payments as loans.
1.636-2 Production payments retained in leasing transactions.
1.636-3 Definitions.
1.636-4 Effective dates of section 636.

                         Continental Shelf Areas

1.638-1 Continental Shelf areas.
1.638-2 Effective date.
1.639-1.640 [Reserved]

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Sections 1.504-1 and 1.504-2 also issued under 26 U.S.C. 504(b).
    Section1.514(c)-2 also issued under 26 U.S.C. 514(c)(9)(E)(iii).
    Section1.527-9 also issued under 26 U.S.C. 527(h)(2)(B)(i).
    Section1.585-5 through 1.585-8 also issued under 26 U.S.C. 
585(b)(3).
    Section1.597-1 through 1.597-7 also issued under 26 U.S.C. 597 and 
1502.
    Section1.597-8 also issued under 26 U.S.C. 597.

    Source: T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 
1960, unless otherwise noted.

                          Exempt Organizations



General Rule--Table of Contents




Sec. 1.501(a)-1  Exemption from taxation.

    (a) In general; proof of exemption. (1) Section 501(a) provides an 
exemption from income taxes for organizations which are described in 
section 501 (c) or (d) and section 401(a), unless such organization is a 
feeder organization (see section 502), or unless it engages in a 
transaction described in section 503. However, the exemption does not 
extend to unrelated business taxable income of such an organization (see 
part III (Section 511 and following), subchapter F, chapter 1 of the 
Code).
    (2) An organization, other than an employees' trust described in 
section 401(a), is not exempt from tax merely because it is not 
organized and operated for profit. In order to establish its exemption, 
it is necessary that every such organization claiming exemption file an 
application form as set forth below with the district director for the 
internal revenue district in which is located the principal place of 
business or principal office of the organization. Subject only to the 
Commissioner's inherent power to revoke rulings because of a change in 
the law or regulations or for other good cause, an organization that has 
been determined by the Commissioner or the district director to be 
exempt under section 501(a) or the corresponding provision of prior law 
may rely upon such determination so long as there are no substantial 
changes in the organization's character, purposes,

[[Page 10]]

or methods of operation. An organization which has been determined to be 
exempt under the provisions of the Internal Revenue Code of 1939 or 
prior law is not required to secure a new determination of exemption 
merely because of the enactment of the Internal Revenue Code of 1954 
unless affected by substantive changes in law made by such Code.
    (3) An organization claiming exemption under section 501(a) and 
described in any paragraph of section 501(c) (other than section 
501(c)(1) shall file the form of application prescribed by the 
Commissioner and shall include thereon such information as required by 
such form and the instructions issued with respect thereto. For rules 
relating to the obtaining of a determination of exempt status by an 
employees' trust described in section 401(a), see the regulations under 
section 401.
    (b) Additional proof by particular classes of organizations. (1) 
Organizations mentioned below shall submit with and as a part of their 
applications the following information:
    (i) Mutual insurance companies shall submit copies of the policies 
or certificates of membership issued by them.
    (ii) In the case of title holding companies described in section 
501(c)(2), if the organization for which title is held has not been 
specifically notified in writing by the Internal Revenue Service that it 
is held to be exempt under section 501(a), the title holding company 
shall submit the information indicated herein as necessary for a 
determination of the status of the organization for which title is held.
    (iii) An organization described in section 501(c)(3) shall submit 
with, and as a part of, an application filed after July 26, 1959, a 
detailed statement of its proposed activities.
    (2) In addition to the information specifically called for by this 
section, the Commissioner may require any additional information deemed 
necessary for a proper determination of whether a particular 
organization is exempt under section 501(a), and when deemed advisable 
in the interest of an efficient administration of the internal revenue 
laws, he may in the cases of particular types of organizations prescribe 
the form in which the proof of exemption shall be furnished.
    (3) An organization claiming to be specifically exempted by section 
6033(a) from filing annual returns shall submit with and as a part of 
its application a statement of all the facts on which it bases its 
claim.
    (c) Private shareholder or individual defined. The words private 
shareholder or individual in section 501 refer to persons having a 
personal and private interest in the activities of the organization.
    (d) Requirement of annual returns. For the annual return 
requirements of organizations exempt under section 501(a), see section 
6033 and Sec. 1.6033-1.
    (e) Certain Puerto Rican pension, etc., trusts. Effective for 
taxable years beginning after December 31, 1973, section 1022(i)(1) of 
the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 
942) provides that trusts under certain Puerto Rican pension, etc., 
plans (as defined under P.R. Laws Ann. tit. 13, section 3165, and the 
articles thereunder), all of the participants of which are residents of 
the Commonwealth of Puerto Rico, are to be treated only for purposes of 
section 501(a) as trusts described in section 401(a). The practical 
effect of section 1022(i)(1) is to exempt these trusts from U.S. income 
tax on income from their U.S. investments. For purposes of section 
1022(i)(1), the term residents of the Commonwealth of Puerto Rico means 
bona fide residents of Puerto Rico, and persons who perform labor or 
services primarily within the Commonwealth of Puerto Rico, regardless of 
residence for other purposes, and the term participants is restricted to 
current employees who are not excluded under the eligibility provisions 
of the plan.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7428, 41 FR 
34619, Aug. 16, 1976; T.D. 7859, 47 FR 54298, Dec. 2, 1982]



Sec. 1.501(c)(2)-1  Corporations organized to hold title to property for 

exempt organizations.

    (a) A corporation described in section 501(c)(2) and otherwise 
exempt from tax under section 501(a) is taxable upon its unrelated 
business taxable income. For taxable years beginning before January

[[Page 11]]

1, 1970, see Sec. 1.511-2(c)(4). Since a corporation described in 
section 501(c)(2) cannot be exempt under section 501(a) if it engages in 
any business other than that of holding title to property and collecting 
income therefrom, it cannot have unrelated business taxable income as 
defined in section 512 other than income which is treated as unrelated 
business taxable income solely because of the applicability of section 
512(a)(3)(C); or debt financed income which is treated as unrelated 
business taxable income solely because of section 514; or certain 
interest, annuities, royalties, or rents which are treated as unrelated 
business taxable income solely because of section 512(b) (3)(B)(ii) or 
(13). Similarly, exempt status under section 501(c)(2) shall not be 
affected where certain rents from personal property leased with real 
property are treated as unrelated business taxable income under section 
512(b)(3)(A)(ii) solely because such rents attributable to such personal 
property are more than incidental when compared to the total rents 
received or accrued under the lease, or under section 512(b)(3)(B)(i) 
solely because such rents attributable to such personal property exceed 
50 percent of the total rents received or accrued under the lease.
    (b) A corporation described in section 501(c)(2) cannot accumulate 
income and retain its exemption, but it must turn over the entire amount 
of such income, less expenses, to an organization which is itself exempt 
from tax under section 501(a).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7658, 45 FR 
33972, May 21, 1980]



Sec. 1.501(c)(3)-1  Organizations organized and operated for religious, 

charitable, scientific, testing for public safety, literary, or educational 

purposes, or for the prevention of cruelty to children or animals.

    (a) Organizational and operational tests. (1) In order to be exempt 
as an organization described in section 501(c)(3), an organization must 
be both organized and operated exclusively for one or more of the 
purposes specified in such section. If an organization fails to meet 
either the organizational test or the operational test, it is not 
exempt.
    (2) The term exempt purpose or purposes, as used in this section, 
means any purpose or purposes specified in section 501(c)(3), as defined 
and elaborated in paragraph (d) of this section.
    (b) Organizational test--(1) In general. (i) An organization is 
organized exclusively for one or more exempt purposes only if its 
articles of organization (referred to in this section as its articles) 
as defined in subparagraph (2) of this paragraph:
    (a) Limit the purposes of such organization to one or more exempt 
purposes; and
    (b) Do not expressly empower the organization to engage, otherwise 
than as an insubstantial part of its activities, in activities which in 
themselves are not in furtherance of one or more exempt purposes.
    (ii) In meeting the organizational test, the organization's 
purposes, as stated in its articles, may be as broad as, or more 
specific than, the purposes stated in section 501(c)(3). Therefore, an 
organization which, by the terms of its articles, is formed for literary 
and scientific purposes within the meaning of section 501(c)(3) of the 
Code shall, if it otherwise meets the requirements in this paragraph, be 
considered to have met the organizational test. Similarly, articles 
stating that the organization is created solely to receive contributions 
and pay them over to organizations which are described in section 
501(c)(3) and exempt from taxation under section 501(a)) are sufficient 
for purposes of the organizational test. Moreover, it is sufficient if 
the articles set for the purpose of the organization to be the operation 
of a school for adult education and describe in detail the manner of the 
operation of such school. In addition, if the articles state that the 
organization is formed for charitable purposes, such articles ordinarily 
shall be sufficient for purposes of the organizational test (see 
subparagraph (5) of this paragraph for rules relating to construction of 
terms).
    (iii) An organization is not organized exclusively for one or more 
exempt purposes if its articles expressly empower it to carry on, 
otherwise than as an insubstantial part of its activities,

[[Page 12]]

activities which are not in furtherance of one or more exempt purposes, 
even though such organization is, by the terms of such articles, created 
for a purpose that is no broader than the purposes specified in section 
501(c)(3). Thus, an organization that is empowered by its articles to 
engage in a manufacturing business, or to engage in the operation of a 
social club does not meet the organizational test regardless of the fact 
that its articles may state that such organization is created for 
charitable purposes within the meaning of section 501(c)(3) of the Code.
    (iv) In no case shall an organization be considered to be organized 
exclusively for one or more exempt purposes, if, by the terms of its 
articles, the purposes for which such organization is created are 
broader than the purposes specified in section 501(c)(3). The fact that 
the actual operations of such an organization have been exclusively in 
furtherance of one or more exempt purposes shall not be sufficient to 
permit the organization to meet the organizational test. Similarly, such 
an organization will not meet the organizational test as a result of 
statements or other evidence that the members thereof intend to operate 
only in furtherance of one or more exempt purposes.
    (v) An organization must, in order to establish its exemption, 
submit a detailed statement of its proposed activities with and as a 
part of its application for exemption (see paragraph (b) of Sec. 
1.501(a)-1).
    (2) Articles of organization. For purposes of this section, the term 
articles of organization or articles includes the trust instrument, the 
corporate charter, the articles of association, or any other written 
instrument by which an organization is created.
    (3) Authorization of legislative or political activities. An 
organization is not organized exclusively for one or more exempt 
purposes if its articles expressly empower it:
    (i) To devote more than an insubstantial part of its activities to 
attempting to influence legislation by propaganda or otherwise; or
    (ii) Directly or indirectly to participate in, or intervene in 
(including the publishing or distributing of statements), any political 
campaign on behalf of or in opposition to any candidate for public 
office; or
    (iii) To have objectives and to engage in activities which 
characterize it as an action organization as defined in paragraph (c)(3) 
of this section.


The terms used in subdivisions (i), (ii), and (iii) of this subparagraph 
shall have the meanings provided in paragraph (c)(3) of this section. An 
organization's articles will not violate the provisions of paragraph 
(b)(3)(i) of this section even though the organization's articles 
expressly empower it to make the election provided for in section 501(h) 
with respect to influencing legislation and, only if it so elects, to 
make lobbying or grass roots expenditures that do not normally exceed 
the ceiling amounts prescribed by section 501(h)(2) (B) and (D).
    (4) Distribution of assets on dissolution. An organization is not 
organized exclusively for one or more exempt purposes unless its assets 
are dedicated to an exempt purpose. An organization's assets will be 
considered dedicated to an exempt purpose, for example, if, upon 
dissolution, such assets would, by reason of a provision in the 
organization's articles or by operation of law, be distributed for one 
or more exempt purposes, or to the Federal Government, or to a State or 
local government, for a public purpose, or would be distributed by a 
court to another organization to be used in such manner as in the 
judgment of the court will best accomplish the general purposes for 
which the dissolved organization was organized. However, an organization 
does not meet the organizational test if its articles or the law of the 
State in which it was created provide that its assets would, upon 
dissolution, be distributed to its members or shareholders.
    (5) Construction of terms. The law of the State in which an 
organization is created shall be controlling in construing the terms of 
its articles. However, any organization which contends that such terms 
have under State law a different meaning from their generally accepted 
meaning must establish such special meaning by clear and convincing 
reference to relevant court decisions, opinions of the State attorney-

[[Page 13]]

general, or other evidence of applicable State law.
    (6) Applicability of the organizational test. A determination by the 
Commissioner or a district director that an organization is described in 
section 501(c)(3) and exempt under section 501(a) will not be granted 
after July 26, 1959 (regardless of when the application is filed), 
unless such organization meets the organizational test prescribed by 
this paragraph. If, before July 27, 1959, an organization has been 
determined by the Commissioner or district director to be exempt as an 
organization described in section 501(c)(3) or in a corresponding 
provision of prior law and such determination has not been revoked 
before such date, the fact that such organization does not meet the 
organizational test prescribed by this paragraph shall not be a basis 
for revoking such determination. Accordingly, an organization which has 
been determined to be exempt before July 27, 1959, and which does not 
seek a new determination of exemption is not required to amend its 
articles of organization to conform to the rules of this paragraph, but 
any organization which seeks a determination of exemption after July 26, 
1959, must have articles of organization which meet the rules of this 
paragraph. For the rules relating to whether an organization determined 
to be exempt before July 27, 1959, is organized exclusively for one or 
more exempt purposes, see 26 CFR (1939) 39.101(6)-1 (Regulations 118) as 
made applicable to the Code by Treasury Decision 6091, approved August 
16, 1954 (19 FR 5167; C.B. 1954-2, 47).
    (c) Operational test--(1) Primary activities. An organization will 
be regarded as operated exclusively for one or more exempt purposes only 
if it engages primarily in activities which accomplish one or more of 
such exempt purposes specified in section 501(c)(3). An organization 
will not be so regarded if more than an insubstantial part of its 
activities is not in furtherance of an exempt purpose.
    (2) Distribution of earnings. An organization is not operated 
exclusively for one or more exempt purposes if its net earnings inure in 
whole or in part to the benefit of private shareholders or individuals. 
For the definition of the words private shareholder or individual, see 
paragraph (c) of Sec. 1.501(a)-1.
    (3) Action organizations. (i) An organization is not operated 
exclusively for one or more exempt purposes if it is an action 
organization as defined in subdivisions (ii), (iii), or (iv) of this 
subparagraph.
    (ii) An organization is an action organization if a substantial part 
of its activities is attempting to influence legislation by propaganda 
or otherwise. For this purpose, an organization will be regarded as 
attempting to influence legislation if the organization:
    (a) Contacts, or urges the public to contact, members of a 
legislative body for the purpose of proposing, supporting, or opposing 
legislation; or
    (b) Advocates the adoption or rejection of legislation.


The term legislation, as used in this subdivision, includes action by 
the Congress, by any State legislature, by any local council or similar 
governing body, or by the public in a referendum, initiative, 
constitutional amendment, or similar procedure. An organization will not 
fail to meet the operational test merely because it advocates, as an 
insubstantial part of its activities, the adoption or rejection of 
legislation. An organization for which the expenditure test election of 
section 501(h) is in effect for a taxable year will not be considered an 
action organization by reason of this paragraph (c)(3)(ii) for that year 
if it is not denied exemption from taxation under section 501(a) by 
reason of section 501(h).
    (iii) An organization is an action organization 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, the publication or distribution of written or printed 
statements or the making of oral statements on

[[Page 14]]

behalf of or in opposition to such a candidate.
    (iv) An organization is an action organization if it has the 
following two characteristics: (a) Its main or primary objective or 
objectives (as distinguished from its incidental or secondary 
objectives) may be attained only by legislation or a defeat of proposed 
legislation; and (b) it advocates, or campaigns for, the attainment of 
such main or primary objective or objectives as distinguished from 
engaging in nonpartisan analysis, study, or research and making the 
results thereof available to the public. In determining whether an 
organization has such characteristics, all the surrounding facts and 
circumstances, including the articles and all activities of the 
organization, are to be considered.
    (v) An action organization, described in subdivisions (ii) or (iv) 
of this subparagraph, though it cannot qualify under section 501(c)(3), 
may nevertheless qualify as a social welfare organization under section 
501(c)(4) if it meets the requirements set out in paragraph (a) of Sec. 
1.501(c)(4)-1.
    (d) Exempt purposes--(1) In general. (i) An organization may be 
exempt as an organization described in section 501(c)(3) if it is 
organized and operated exclusively for one or more of the following 
purposes:
    (a) Religious,
    (b) Charitable,
    (c) Scientific,
    (d) Testing for public safety,
    (e) Literary,
    (f) Educational, or
    (g) Prevention of cruelty to children or animals.
    (ii) An organization is not organized or operated exclusively for 
one or more of the purposes specified in subdivision (i) of this 
subparagraph unless it serves a public rather than a private interest. 
Thus, to meet the requirement of this subdivision, it is necessary for 
an organization to establish that it is not organized or operated for 
the benefit of private interests such as designated individuals, the 
creator or his family, shareholders of the organization, or persons 
controlled, directly or indirectly, by such private interests.
    (iii) Examples. The following examples illustrate the requirement of 
paragraph (d)(1)(ii) of this section that an organization serve a public 
rather than a private interest:

    Example 1. (i) O is an educational organization the purpose of which 
is to study history and immigration. O's educational activities include 
sponsoring lectures and publishing a journal. The focus of O's 
historical studies is the genealogy of one family, tracing the descent 
of its present members. O actively solicits for membership only 
individuals who are members of that one family. O's research is directed 
toward publishing a history of that family that will document the 
pedigrees of family members. A major objective of O's research is to 
identify and locate living descendants of that family to enable those 
descendants to become acquainted with each other.
    (ii) O's educational activities primarily serve the private 
interests of members of a single family rather than a public interest. 
Therefore, O is operated for the benefit of private interests in 
violation of the restriction on private benefit in paragraph (d)(1)(ii) 
of this section. Based on these facts and circumstances, O is not 
operated exclusively for exempt purposes and, therefore, is not 
described in section 501(c)(3).
    Example 2. (i) O is an art museum. O's principal activity is 
exhibiting art created by a group of unknown but promising local 
artists. O's activity, including organized tours of its art collection, 
promotes the arts. O is governed by a board of trustees unrelated to the 
artists whose work O exhibits. All of the art exhibited is offered for 
sale at prices set by the artist. Each artist whose work is exhibited 
has a consignment arrangement with O. Under this arrangement, when art 
is sold, the museum retains 10 percent of the selling price to cover the 
costs of operating the museum and gives the artist 90 percent.
    (ii) The artists in this situation directly benefit from the 
exhibition and sale of their art. As a result, the principal activity of 
O serves the private interests of these artists. Because O gives 90 
percent of the proceeds from its sole activity to the individual 
artists, the direct benefits to the artists are substantial and O's 
provision of these benefits to the artists is more than incidental to 
its other purposes and activities. This arrangement causes O to be 
operated for the benefit of private interests in violation of the 
restriction on private benefit in paragraph (d)(1)(ii) of this section. 
Based on these facts and circumstances, O is not operated exclusively 
for exempt purposes and, therefore, is not described in section 
501(c)(3).
    Example 3. (i) O is an educational organization the purpose of which 
is to train individuals in a program developed by P, O's president. The 
program is of interest to academics and professionals, representatives 
of whom serve on an advisory panel to O. All of

[[Page 15]]

the rights to the program are owned by Company K, a for-profit 
corporation owned by P. Prior to the existence of O, the teaching of the 
program was conducted by Company K. O licenses, from Company K, the 
right to conduct seminars and lectures on the program and to use the 
name of the program as part of O's name, in exchange for specified 
royalty payments. Under the license agreement, Company K provides O with 
the services of trainers and with course materials on the program. O may 
develop and copyright new course materials on the program but all such 
materials must be assigned to Company K without consideration if and 
when the license agreement is terminated. Company K sets the tuition for 
the seminars and lectures on the program conducted by O. O has agreed 
not to become involved in any activity resembling the program or its 
implementation for 2 years after the termination of O's license 
agreement.
    (ii) O's sole activity is conducting seminars and lectures on the 
program. This arrangement causes O to be operated for the benefit of P 
and Company K in violation of the restriction on private benefit in 
paragraph (d)(1)(ii) of this section, regardless of whether the royalty 
payments from O to Company K for the right to teach the program are 
reasonable. Based on these facts and circumstances, O is not operated 
exclusively for exempt purposes and, therefore, is not described in 
section 501(c)(3).
    (iv) Since each of the purposes specified in subdivision (i) of this 
subparagraph is an exempt purpose in itself, an organization may be 
exempt if it is organized and operated exclusively for any one or more 
of such purposes. If, in fact, an organization is organized and operated 
exclusively for an exempt purpose or purposes, exemption will be granted 
to such an organization regardless of the purpose or purposes specified 
in its application for exemption. For example, if an organization claims 
exemption on the ground that it is educational, exemption will not be 
denied if, in fact, it is charitable.
    (2) Charitable defined. The term charitable is used in section 
501(c)(3) in its generally accepted legal sense and is, therefore, not 
to be construed as limited by the separate enumeration in section 
501(c)(3) of other tax-exempt purposes which may fall within the broad 
outlines of charity as developed by judicial decisions. Such term 
includes: Relief of the poor and distressed or of the underprivileged; 
advancement of religion; advancement of education or science; erection 
or maintenance of public buildings, monuments, or works; lessening of 
the burdens of Government; and promotion of social welfare by 
organizations designed to accomplish any of the above purposes, or (i) 
to lessen neighborhood tensions; (ii) to eliminate prejudice and 
discrimination; (iii) to defend human and civil rights secured by law; 
or (iv) to combat community deterioration and juvenile delinquency. The 
fact that an organization which is organized and operated for the relief 
of indigent persons may receive voluntary contributions from the persons 
intended to be relieved will not necessarily prevent such organization 
from being exempt as an organization organized and operated exclusively 
for charitable purposes. The fact that an organization, in carrying out 
its primary purpose, advocates social or civic changes or presents 
opinion on controversial issues with the intention of molding public 
opinion or creating public sentiment to an acceptance of its views does 
not preclude such organization from qualifying under section 501(c)(3) 
so long as it is not an action organization of any one of the types 
described in paragraph (c)(3) of this section.
    (3) Educational defined--(i) In general. The term educational, as 
used in section 501(c)(3), relates to:
    (a) The instruction or training of the individual for the purpose of 
improving or developing his capabilities; or
    (b) The instruction of the public on subjects useful to the 
individual and beneficial to the community.


An organization may be educational even though it advocates a particular 
position or viewpoint so long as it presents a sufficiently full and 
fair exposition of the pertinent facts as to permit an individual or the 
public to form an independent opinion or conclusion. On the other hand, 
an organization is not educational if its principal function is the mere 
presentation of unsupported opinion.
    (ii) Examples of educational organizations. The following are 
examples of organizations which, if they otherwise meet the requirements 
of this section, are educational:

    Example 1. An organization, such as a primary or secondary school, a 
college, or a

[[Page 16]]

professional or trade school, which has a regularly scheduled 
curriculum, a regular faculty, and a regularly enrolled body of students 
in attendance at a place where the educational activities are regularly 
carried on.
    Example 2. An organization whose activities consist of presenting 
public discussion groups, forums, panels, lectures, or other similar 
programs. Such programs may be on radio or television.
    Example 3. An organization which presents a course of instruction by 
means of correspondence or through the utilization of television or 
radio.
    Example 4. useums, zoos, planetariums, symphony orchestras, and 
other similar organizations.

    (4) Testing for public safety defined. The term testing for public 
safety, as used in section 501(c)(3), includes the testing of consumer 
products, such as electrical products, to determine whether they are 
safe for use by the general public.
    (5) Scientific defined. (i) Since an organization may meet the 
requirements of section 501(c)(3) only if it serves a public rather than 
a private interest, a scientific organization must be organized and 
operated in the public interest (see subparagraph (1)(ii) of this 
paragraph). Therefore, the term scientific, as used in section 
501(c)(3), includes the carrying on of scientific research in the public 
interest. Research when taken alone is a word with various meanings; it 
is not synonymous with scientific; and the nature of particular research 
depends upon the purpose which it serves. For research to be scientific, 
within the meaning of section 501(c)(3), it must be carried on in 
furtherance of a scientific purpose. The determination as to whether 
research is scientific does not depend on whether such research is 
classified as fundamental or basic as contrasted with applied or 
practical. On the other hand, for purposes of the exclusion from 
unrelated business taxable income provided by section 512(b)(9), it is 
necessary to determine whether the organization is operated primarily 
for purposes of carrying on fundamental, as contrasted with applied, 
research.
    (ii) Scientific research does not include activities of a type 
ordinarily carried on as an incident to commercial or industrial 
operations, as, for example, the ordinary testing or inspection of 
materials or products or the designing or construction of equipment, 
buildings, etc.
    (iii) Scientific research will be regarded as carried on in the 
public interest:
    (a) If the results of such research (including any patents, 
copyrights, processes, or formulae resulting from such research) are 
made available to the public on a nondiscriminatory basis;
    (b) If such research is performed for the United States, or any of 
its agencies or instrumentalities, or for a State or political 
subdivision thereof; or
    (c) If such research is directed toward benefiting the public. The 
following are examples of scientific research which will be considered 
as directed toward benefiting the public, and, therefore, which will be 
regarded as carried on in the public interest: (1) Scientific research 
carried on for the purpose of aiding in the scientific education of 
college or university students; (2) scientific research carried on for 
the purpose of obtaining scientific information, which is published in a 
treatise, thesis, trade publication, or in any other form that is 
available to the interested public; (3) scientific research carried on 
for the purpose of discovering a cure for a disease; or (4) scientific 
research carried on for the purpose of aiding a community or 
geographical area by attracting new industry to the community or area or 
by encouraging the development of, or retention of, an industry in the 
community or area. Scientific research described in this subdivision 
will be regarded as carried on in the public interest even though such 
research is performed pursuant to a contract or agreement under which 
the sponsor or sponsors of the research have the right to obtain 
ownership or control of any patents, copyrights, processes, or formulae 
resulting from such research.
    (iv) An organization will not be regarded as organized and operated 
for the purpose of carrying on scientific research in the public 
interest and, consequently, will not qualify under section 501(c)(3) as 
a scientific organization, if:
    (a) Such organization will perform research only for persons which 
are (directly or indirectly) its creators and

[[Page 17]]

which are not described in section 501(c)(3), or
    (b) Such organization retains (directly or indirectly) the ownership 
or control of more than an insubstantial portion of the patents, 
copyrights, processes, or formulae resulting from its research and does 
not make such patents, copyrights, processes, or formulae available to 
the public. For purposes of this subdivision, a patent, copyright, 
process, or formula shall be considered as made available to the public 
if such patent, copyright, process, or formula is made available to the 
public on a nondiscriminatory basis. In addition, although one person is 
granted the exclusive right to the use of a patent, copyright, process, 
or formula, such patent, copyright, process, or formula shall be 
considered as made available to the public if the granting of such 
exclusive right is the only practicable manner in which the patent, 
copyright, process, or formula can be utilized to benefit the public. In 
such a case, however, the research from which the patent, copyright, 
process, or formula resulted will be regarded as carried on in the 
public interest (within the meaning of subdivision (iii) of this 
subparagraph) only if it is carried on for a person described in 
subdivision (iii)(b) of this subparagraph or if it is scientific 
research described in subdivision (iii)(c) of this subparagraph.
    (v) The fact that any organization (including a college, university, 
or hospital) carries on research which is not in furtherance of an 
exempt purpose described in section 501(c)(3) will not preclude such 
organization from meeting the requirements of section 501(c)(3) so long 
as the organization meets the organizational test and is not operated 
for the primary purpose of carrying on such research (see paragraph (e) 
of this section, relating to organizations carrying on a trade or 
business). See paragraph (a)(5) of Sec. 1.513-2, with respect to 
research which constitutes an unrelated trade or business, and section 
512(b) (7), (8), and (9), with respect to income derived from research 
which is excludable from the tax on unrelated business income.
    (vi) The regulations in this subparagraph are applicable with 
respect to taxable years beginning after December 31, 1960.
    (e) Organizations carrying on trade or business--(1) In general. An 
organization may meet the requirements of section 501(c)(3) although it 
operates a trade or business as a substantial part of its activities, if 
the operation of such trade or business is in furtherance of the 
organization's exempt purpose or purposes and if the organization is not 
organized or operated for the primary purpose of carrying on an 
unrelated trade or business, as defined in section 513. In determining 
the existence or nonexistence of such primary purpose, all the 
circumstances must be considered, including the size and extent of the 
trade or business and the size and extent of the activities which are in 
furtherance of one or more exempt purposes. An organization which is 
organized and operated for the primary purpose of carrying on an 
unrelated trade or business is not exempt under section 501(c)(3) even 
though it has certain religious purposes, its property is held in 
common, and its profits do not inure to the benefit of individual 
members of the organization. See, however, section 501(d) and Sec. 
1.501(d)-1, relating to religious and apostolic organizations.
    (2) Taxation of unrelated business income. For provisions relating 
to the taxation of unrelated business income of certain organizations 
described in section 501(c)(3), see sections 511 to 515, inclusive, and 
the regulations thereunder.
    (f) Interaction with section 4958--(1) Application process. An 
organization that applies for recognition of exemption under section 
501(a) as an organization described in section 501(c)(3) must establish 
its eligibility under this section. The Commissioner may deny an 
application for exemption for failure to establish any of section 
501(c)(3)'s requirements for exemption. Section 4958 does not apply to 
transactions with an organization that has failed to establish that it 
satisfies all of the requirements for exemption under section 501(c)(3). 
See Sec. 53.4958-2.
    (2) Substantive requirements for exemption still apply to applicable 
tax-exempt organizations described in section 501(c)(3)--(i) In general. 
Regardless of whether a particular transaction is

[[Page 18]]

subject to excise taxes under section 4958, the substantive requirements 
for tax exemption under section 501(c)(3) still apply to an applicable 
tax-exempt organization (as defined in section 4958(e) and Sec. 
53.4958-2) described in section 501(c)(3) whose disqualified persons or 
organization managers are subject to excise taxes under section 4958. 
Accordingly, an organization will no longer meet the requirements for 
tax-exempt status under section 501(c)(3) if the organization fails to 
satisfy the requirements of paragraph (b), (c) or (d) of this section. 
See Sec. 53.4958-8(a).
    (ii) Determination of whether revocation of tax-exempt status is 
appropriate when section 4958 excise taxes also apply. In determining 
whether to continue to recognize the tax-exempt status of an applicable 
tax-exempt organization (as defined in section 4958(e) and Sec. 
53.4958-2) described in section 501(c)(3) that engages in one or more 
excess benefit transactions (as defined in section 4958(c) and Sec. 
53.4958-4) that violate the prohibition on inurement under section 
501(c)(3), the Commissioner will consider all relevant facts and 
circumstances, including, but not limited to, the following--
    (A) The size and scope of the organization's regular and ongoing 
activities that further exempt purposes before and after the excess 
benefit transaction or transactions occurred;
    (B) The size and scope of the excess benefit transaction or 
transactions (collectively, if more than one) in relation to the size 
and scope of the organization's regular and ongoing activities that 
further exempt purposes;
    (C) Whether the organization has been involved in multiple excess 
benefit transactions with one or more persons;
    (D) Whether the organization has implemented safeguards that are 
reasonably calculated to prevent excess benefit transactions; and
    (E) Whether the excess benefit transaction has been corrected 
(within the meaning of section 4958(f)(6) and Sec. 53.4958-7), or the 
organization has made good faith efforts to seek correction from the 
disqualified person(s) who benefited from the excess benefit 
transaction.
    (iii) All factors will be considered in combination with each other. 
Depending on the particular situation, the Commissioner may assign 
greater or lesser weight to some factors than to others. The factors 
listed in paragraphs (f)(2)(ii)(D) and (E) of this section will weigh 
more heavily in favor of continuing to recognize exemption where the 
organization discovers the excess benefit transaction or transactions 
and takes action before the Commissioner discovers the excess benefit 
transaction or transactions. Further, with respect to the factor listed 
in paragraph (f)(2)(ii)(E) of this section, correction after the excess 
benefit transaction or transactions are discovered by the Commissioner, 
by itself, is never a sufficient basis for continuing to recognize 
exemption.
    (iv) Examples. The following examples illustrate the principles of 
paragraph (f)(2)(ii) of this section. For purposes of each example, 
assume that O is an applicable tax-exempt organization (as defined in 
section 4958(e) and Sec. 53.4958-2) described in section 501(c)(3). The 
examples read as follows:

    Example 1. (i) O was created as a museum for the purpose of 
exhibiting art to the general public. In Years 1 and 2, O engages in 
fundraising and in selecting, leasing, and preparing an appropriate 
facility for a museum. In Year 3, a new board of trustees is elected. 
All of the new trustees are local art dealers. Beginning in Year 3 and 
continuing to the present, O uses a substantial portion of its revenues 
to purchase art solely from its trustees at prices that exceed fair 
market value. O exhibits and offers for sale all of the art it 
purchases. O's Form 1023, ``Application for Recognition of Exemption,'' 
did not disclose the possibility that O would purchase art from its 
trustees.
    (ii) O's purchases of art from its trustees at more than fair market 
value constitute excess benefit transactions between an applicable tax-
exempt organization and disqualified persons under section 4958. 
Therefore, these transactions are subject to the applicable excise taxes 
provided in that section. In addition, O's purchases of art from its 
trustees at more than fair market value violate the proscription against 
inurement under section 501(c)(3) and paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. Beginning in Year 3, O does not 
engage primarily in regular and ongoing activities that further exempt 
purposes because a substantial portion of O's activities

[[Page 19]]

consists of purchasing art from its trustees and dealing in such art in 
a manner similar to a commercial art gallery. The size and scope of the 
excess benefit transactions collectively are significant in relation to 
the size and scope of any of O's ongoing activities that further exempt 
purposes. O has been involved in multiple excess benefit transactions, 
namely, purchases of art from its trustees at more than fair market 
value. O has not implemented safeguards that are reasonably calculated 
to prevent such improper purchases in the future. The excess benefit 
transactions have not been corrected, nor has O made good faith efforts 
to seek correction from the disqualified persons who benefited from the 
excess benefit transactions (the trustees). The trustees continue to 
control O's Board. Based on the application of the factors to these 
facts, O is no longer described in section 501(c)(3) effective in Year 
3.
    Example 2. (i) The facts are the same as in Example 1, except that 
in Year 4, O's entire board of trustees resigns, and O no longer offers 
all exhibited art for sale. The former board is replaced with members of 
the community who are not in the business of buying or selling art and 
who have skills and experience running charitable and educational 
programs and institutions. O promptly discontinues the practice of 
purchasing art from current or former trustees, adopts a written 
conflicts of interest policy, adopts written art valuation guidelines, 
hires legal counsel to recover the excess amounts O had paid its former 
trustees, and implements a new program of activities to further the 
public's appreciation of the arts.
    (ii) O's purchases of art from its former trustees at more than fair 
market value constitute excess benefit transactions between an 
applicable tax-exempt organization and disqualified persons under 
section 4958. Therefore, these transactions are subject to the 
applicable excise taxes provided in that section. In addition, O's 
purchases of art from its trustees at more than fair market value 
violate the proscription against inurement under section 501(c)(3) and 
paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. In Year 3, O does not engage 
primarily in regular and ongoing activities that further exempt 
purposes. However, in Year 4, O elects a new board of trustees comprised 
of individuals who have skills and experience running charitable and 
educational programs and implements a new program of activities to 
further the public's appreciation of the arts. As a result of these 
actions, beginning in Year 4, O engages in regular and ongoing 
activities that further exempt purposes. The size and scope of the 
excess benefit transactions that occurred in Year 3, taken collectively, 
are significant in relation to the size and scope of O's regular and 
ongoing exempt function activities that were conducted in Year 3. 
Beginning in Year 4, however, as O's exempt function activities grow, 
the size and scope of the excess benefit transactions that occurred in 
Year 3 become less and less significant as compared to the size and 
scope of O's regular and ongoing exempt function activities. O was 
involved in multiple excess benefit transactions in Year 3. However, by 
discontinuing its practice of purchasing art from its current and former 
trustees, by replacing its former board with independent members of the 
community, and by adopting a conflicts of interest policy and art 
valuation guidelines, O has implemented safeguards that are reasonably 
calculated to prevent future violations. In addition, O has made a good 
faith effort to seek correction from the disqualified persons who 
benefited from the excess benefit transactions (its former trustees). 
Based on the application of the factors to these facts, O continues to 
meet the requirements for tax exemption under section 501(c)(3).
    Example 3. (i) O conducts educational programs for the benefit of 
the general public. Since its formation, O has employed its founder, C, 
as its Chief Executive Officer. Beginning in Year 5 of O's operations 
and continuing to the present, C caused O to divert significant portions 
of O's funds to pay C's personal expenses. The diversions by C 
significantly reduced the funds available to conduct O's ongoing 
educational programs. The board of trustees never authorized C to cause 
O to pay C's personal expenses from O's funds. Certain members of the 
board were aware that O was paying C's personal expenses. However, the 
board did not terminate C's employment and did not take any action to 
seek repayment from C or to prevent C from continuing to divert O's 
funds to pay C's personal expenses. C claimed that O's payments of C's 
personal expenses represented loans from O to C. However, no 
contemporaneous loan documentation exists, and C never made any payments 
of principal or interest.
    (ii) The diversions of O's funds to pay C's personal expenses 
constitute excess benefit transactions between an applicable tax-exempt 
organization and a disqualified person under section 4958. Therefore, 
these transactions are subject to the applicable excise taxes provided 
in that section. In addition, these transactions violate the 
proscription against inurement under section 501(c)(3) and paragraph 
(c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transactions occurred. However, the size and

[[Page 20]]

scope of the excess benefit transactions engaged in by O beginning in 
Year 5, collectively, are significant in relation to the size and scope 
of O's activities that further exempt purposes. Moreover, O has been 
involved in multiple excess benefit transactions. O has not implemented 
any safeguards that are reasonably calculated to prevent future 
diversions. The excess benefit transactions have not been corrected, nor 
has O made good faith efforts to seek correction from C, the 
disqualified person who benefited from the excess benefit transactions. 
Based on the application of the factors to these facts, O is no longer 
described in section 501(c)(3) effective in Year 5.
    Example 4. (i) O conducts activities that further exempt purposes. O 
uses several buildings in the conduct of its exempt activities. In Year 
1, O sold one of the buildings to Company K for an amount that was 
substantially below fair market value. The sale was a significant event 
in relation to O's other activities. C, O's Chief Executive Officer, 
owns all of the voting stock of Company K. When O's board of trustees 
approved the transaction with Company K, the board did not perform due 
diligence that could have made it aware that the price paid by Company K 
to acquire the building was below fair market value. Subsequently, but 
before the IRS commences an examination of O, O's board of trustees 
determines that Company K paid less than the fair market value for the 
building. Thus, O concludes that an excess benefit transaction occurred. 
After the board makes this determination, it promptly removes C as Chief 
Executive Officer, terminates C's employment with O, and hires legal 
counsel to recover the excess benefit from Company K. In addition, O 
promptly adopts a conflicts of interest policy and new contract review 
procedures designed to prevent future recurrences of this problem.
    (ii) The sale of the building by O to Company K at less than fair 
market value constitutes an excess benefit transaction between an 
applicable tax-exempt organization and a disqualified person under 
section 4958 in Year 1. Therefore, this transaction is subject to the 
applicable excise taxes provided in that section. In addition, this 
transaction violates the proscription against inurement under section 
501(c)(3) and paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transaction occurred. Although the size and scope of 
the excess benefit transaction were significant in relation to the size 
and scope of O's activities that further exempt purposes, the 
transaction with Company K was a one-time occurrence. By adopting a 
conflicts of interest policy and new contract review procedures and by 
terminating C, O has implemented safeguards that are reasonably 
calculated to prevent future violations. Moreover, O took corrective 
actions before the IRS commenced an examination of O. In addition, O has 
made a good faith effort to seek correction from Company K, the 
disqualified person who benefited from the excess benefit transaction. 
Based on the application of the factors to these facts, O continues to 
be described in section 501(c)(3).
    Example 5. (i) O is a large organization with substantial assets and 
revenues. O conducts activities that further its exempt purposes. O 
employs C as its Chief Financial Officer. During Year 1, O pays $2,500 
of C's personal expenses. O does not make these payments pursuant to an 
accountable plan, as described in Sec. 53.4958-4(a)(4)(ii). In 
addition, O does not report any of these payments on C's Form W-2, 
``Wage and Tax Statement,'' or on a Form 1099-MISC, ``Miscellaneous 
Income,'' for C for Year 1, and O does not report these payments as 
compensation on its Form 990, ``Return of Organization Exempt From 
Income Tax,'' for Year 1. Moreover, none of these payments can be 
disregarded as nontaxable fringe benefits under Sec. 53.4958-4(c)(2) 
and none consisted of fixed payments under an initial contract under 
Sec. 53.4958-4(a)(3). C does not report the $2,500 of payments as 
income on his individual Federal income tax return for Year 1. O does 
not repeat this reporting omission in subsequent years and, instead, 
reports all payments of C's personal expenses not made under an 
accountable plan as income to C.
    (ii) O's payment in Year 1 of $2,500 of C's personal expenses 
constitutes an excess benefit transaction between an applicable tax-
exempt organization and a disqualified person under section 4958. 
Therefore, this transaction is subject to the applicable excise taxes 
provided in that section. In addition, this transaction violates the 
proscription against inurement in section 501(c)(3) and paragraph (c)(2) 
of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O engages in regular and ongoing 
activities that further exempt purposes. The payment of $2,500 of C's 
personal expenses represented only a de minimis portion of O's assets 
and revenues; thus, the size and scope of the excess benefit transaction 
were not significant in relation to the size and scope of O's activities 
that further exempt purposes. The reporting omission that resulted in 
the excess benefit transaction in Year 1 occurred only once and is not 
repeated in subsequent years. Based on the application of the factors to 
these facts, O continues to be described in section 501(c)(3).
    Example 6. (i) O is a large organization with substantial assets and 
revenues. O furthers

[[Page 21]]

its exempt purposes by providing social services to the population of a 
specific geographic area. O has a sizeable workforce of employees and 
volunteers to conduct its work. In Year 1, O's board of directors 
adopted written procedures for setting executive compensation at O. O's 
executive compensation procedures were modeled on the procedures for 
establishing a rebuttable presumption of reasonableness under Sec. 
53.4958-6. In accordance with these procedures, the board appointed a 
compensation committee to gather data on compensation levels paid by 
similarly situated organizations for functionally comparable positions. 
The members of the compensation committee were disinterested within the 
meaning of Sec. 53.4958-6(c)(1)(iii). Based on its research, the 
compensation committee recommended a range of reasonable compensation 
for several of O's existing top executives (the Top Executives). On the 
basis of the committee's recommendations, the board approved new 
compensation packages for the Top Executives and timely documented the 
basis for its decision in board minutes. The board members were all 
disinterested within the meaning of Sec. 53.4958-6(c)(1)(iii). The Top 
Executives were not involved in setting their own compensation. In Year 
1, even though payroll expenses represented a significant portion of O's 
total operating expenses, the total compensation paid to O's Top 
Executives represented only an insubstantial portion of O's total 
payroll expenses. During a subsequent examination, the IRS found that 
the compensation committee relied exclusively on compensation data from 
organizations that perform similar social services to O. The IRS 
concluded, however, that the organizations were not similarly situated 
because they served substantially larger geographic regions with more 
diverse populations and were larger than O in terms of annual revenues, 
total operating budget, number of employees, and number of beneficiaries 
served. Accordingly, the IRS concluded that the compensation committee 
did not rely on ``appropriate data as to comparability'' within the 
meaning of Sec. 53.4958-6(c)(2) and, thus, failed to establish the 
rebuttable presumption of reasonableness under Sec. 53.4958-6. Taking 
O's size and the nature of the geographic area and population it serves 
into account, the IRS concluded that the Top Executives' compensation 
packages for Year 1 were excessive. As a result of the examination, O's 
board added new members to the compensation committee who have expertise 
in compensation matters and also amended its written procedures to 
require the compensation committee to evaluate a number of specific 
factors, including size, geographic area, and population covered by the 
organization, in assessing the comparability of compensation data. O's 
board renegotiated the Top Executives' contracts in accordance with the 
recommendations of the newly constituted compensation committee on a 
going forward basis. To avoid potential liability for damages under 
state contract law, O did not seek to void the Top Executives' 
employment contracts retroactively to Year 1 and did not seek correction 
of the excess benefit amounts from the Top Executives. O did not 
terminate any of the Top Executives.
    (ii) O's payments of excessive compensation to the Top Executives in 
Year 1 constituted excess benefit transactions between an applicable 
tax-exempt organization and disqualified persons under section 4958. 
Therefore, these payments are subject to the applicable excise taxes 
provided under that section, including second-tier taxes if there is no 
correction by the disqualified persons. In addition, these payments 
violate the proscription against inurement under section 501(c)(3) and 
paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transactions occurred. The size and scope of the 
excess benefit transactions, in the aggregate, were not significant in 
relation to the size and scope of O's activities that further exempt 
purposes. O engaged in multiple excess benefit transactions. 
Nevertheless, prior to entering into these excess benefit transactions, 
O had implemented written procedures for setting the compensation of its 
top management that were reasonably calculated to prevent the occurrence 
of excess benefit transactions. O followed these written procedures in 
setting the compensation of the Top Executives for Year 1. Despite the 
board's failure to rely on appropriate comparability data, the fact that 
O implemented and followed these written procedures in setting the 
compensation of the Top Executives for Year 1 is a factor favoring 
continued exemption. The fact that O amended its written procedures to 
ensure the use of appropriate comparability data and renegotiated the 
Top Executives' compensation packages on a going-forward basis are also 
factors favoring continued exemption, even though O did not void the Top 
Executives' existing contracts and did not seek correction from the Top 
Executives. Based on the application of the factors to these facts, O 
continues to be described in section 501(c)(3).

    (3) Applicability. The rules in paragraph (f) of this section will 
apply with respect to excess benefit transactions occurring after March 
28, 2008.
    (g) Applicability of regulations in this section. The regulations in 
this section are, except as otherwise expressly provided, applicable 
with respect to taxable years beginning after July 26, 1959. For the 
rules applicable with respect to

[[Page 22]]

taxable years beginning before July 27, 1959, see 26 CFR (1939) 
39.101(6)-1 (Regulations 118) as made applicable to the Code by Treasury 
Decision 6091, approved August 16, 1954 (19 FR 5167; C.B. 1954-2, 47).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6525, 26 FR 
189, Jan. 11, 1961; T.D. 6939, 32 FR 17661, Dec. 12, 1967; T.D. 7428, 41 
FR 34620, Aug. 16, 1976; T.D. 8308, 55 FR 35587, Aug. 31, 1990; T.D. 
9390, 73 FR 16521, Mar. 28, 2008; T.D. 9390, 73 FR 23069, Apr. 29, 2008]



Sec. 1.501(c)(4)-1  Civic organizations and local associations of employees.

    (a) Civic organizations--(1) In general. A civic league or 
organization may be exempt as an organization described in section 
501(c)(4) if--
    (i) It is not organized or operated for profit; and
    (ii) It is operated exclusively for the promotion of social welfare.
    (2) Promotion of social welfare--(i) In general. An organization is 
operated exclusively for the promotion of social welfare if it is 
primarily engaged in promoting in some way the common good and general 
welfare of the people of the community. An organization embraced within 
this section is one which is operated primarily for the purpose of 
bringing about civic betterments and social improvements. A social 
welfare organization will qualify for exemption as a charitable 
organization if it falls within the definition of charitable set forth 
in paragraph (d)(2) of Sec. 1.501(c)(3)-1 and is not an action 
organization as set forth in paragraph (c)(3) of Sec. 1.501(c)(3)-1.
    (ii) Political or social activities. The promotion of social welfare 
does not include direct or indirect participation or intervention in 
political campaigns on behalf of or in opposition to any candidate for 
public office. Nor is an organization operated primarily for the 
promotion of social welfare if its primary activity is operating a 
social club for the benefit, pleasure, or recreation of its members, or 
is carrying on a business with the general public in a manner similar to 
organizations which are operated for profit. See, however, section 
501(c)(6) and Sec. 1.501(c)(6)-1, relating to business leagues and 
similar organizations. A social welfare organization that is not, at any 
time after October 4, 1976, exempt from taxation as an organization 
described in section 501(c)(3) may qualify under section 501(c)(4) even 
though it is an action organization described in Sec. 1.501(c)(3)-
1(c)(3)(ii) or (iv), if it otherwise qualifies under this section. For 
rules relating to an organization that is, after October 4, 1976, exempt 
from taxation as an organization described in section 501(c)(3), see 
section 504 and Sec. 1.504-1.
    (b) Local associations of employees. Local associations of employees 
described in section 501(c)(4) are expressly entitled to exemption under 
section 501(a). As conditions to exemption, it is required (1) that the 
membership of such an association be limited to the employees of a 
designated person or persons in a particular municipality, and (2) that 
the net earnings of the association be devoted exclusively to 
charitable, educational, or recreational purposes. The word local is 
defined in paragraph (b) of Sec. 1.501(c)(12)-1. See paragraph (d) (2) 
and (3) of Sec. 1.501(c)(3)-1 with reference to the meaning of 
charitable and educational as used in this section.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec. 1.501(c)(5)-1  Labor, agricultural, and horticultural organizations.

    (a) The organizations contemplated by section 501(c)(5) as entitled 
to exemption from income taxation are those which:
    (1) Have no net earnings inuring to the benefit of any member, and
    (2) Have as their objects the betterment of the conditions of those 
engaged in such pursuits, the improvement of the grade of their 
products, and the development of a higher degree of efficiency in their 
respective occupations.
    (b)(1) General rule. An organization is not an organization 
described in section 501(c)(5) if the principal activity of the 
organization is to receive, hold, invest, disburse or otherwise manage 
funds associated with savings or investment plans or programs, including 
pension or other retirement savings plans or programs.

[[Page 23]]

    (2) Exception. Paragraph (b)(1) of this section shall not apply to 
an organization which--
    (i) Is established and maintained by another labor organization 
described in section 501(c)(5) (determined without regard to this 
paragraph (b)(2));
    (ii) Is not directly or indirectly established or maintained in 
whole or in part by one or more--
    (A) Employers;
    (B) Governments or agencies or instrumentalities thereof; or
    (C) Government controlled entities;
    (iii) Is funded by membership dues from members of the labor 
organization described in this paragraph (b)(2) and earnings thereon; 
and
    (iv) Has not at any time after September 2, 1974 (the date of 
enactment of the Employee Retirement Income Security Act of 1974, Pub. 
L. 93-406, 88 Stat. 829) provided for, permitted or accepted employer 
contributions.
    (3) Example. The principles of this paragraph (b) are illustrated by 
the following example:

    Example. Trust A is organized in accordance with a collective 
bargaining agreement between labor union K and multiple employers. Trust 
A forms part of a plan that is established and maintained pursuant to 
the agreement and which covers employees of the signatory employers who 
are members of K. Representatives of both the employers and K serve as 
trustees. A receives contributions from the employers who are subject to 
the agreement. Retirement benefits paid to K's members as specified in 
the agreement are funded exclusively by the employers' contributions and 
accumulated earnings. A also provides information to union members about 
their retirement benefits and assists them with administrative tasks 
associated with the benefits. Most of A's activities are devoted to 
these functions. From time to time, A also participates in the 
renegotiation of the collective bargaining agreement. A's principal 
activity is to receive, hold, invest, disburse, or otherwise manage 
funds associated with a retirement savings plan. In addition, A does not 
satisfy all the requirements of the exception described in paragraph 
(b)(2) of this section. (For example, A accepts contributions from 
employers.) Therefore, A is not a labor organization described in 
section 501(c)(5).

    (c) Organizations described in section 501(c)(5) and otherwise 
exempt from tax under section 501(a) are taxable upon their unrelated 
business taxable income. See part II (section 511 and following), 
subchapter F, chapter 1 of the Code, and the regulations thereunder.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8726, 62 FR 40449, July 29, 1997]



Sec. 1.501(c)(6)-1  Business leagues, chambers of commerce, real estate 

boards, and boards of trade.

    A business league is an association of persons having some common 
business interest, the purpose of which is to promote such common 
interest and not to engage in a regular business of a kind ordinarily 
carried on for profit. It is an organization of the same general class 
as a chamber of commerce or board of trade. Thus, its activities should 
be directed to the improvement of business conditions of one or more 
lines of business as distinguished from the performance of particular 
services for individual persons. An organization whose purpose is to 
engage in a regular business of a kind ordinarily carried on for profit, 
even though the business is conducted on a cooperative basis or produces 
only sufficient income to be self-sustaining, is not a business league. 
An association engaged in furnishing information to prospective 
investors, to enable them to make sound investments, is not a business 
league, since its activities do not further any common business 
interest, even though all of its income is devoted to the purpose 
stated. A stock or commodity exchange is not a business league, a 
chamber of commerce, or a board of trade within the meaning of section 
501(c)(6) and is not exempt from tax. Organizations otherwise exempt 
from tax under this section are taxable upon their unrelated business 
taxable income. See part II (section 511 and following), subchapter F, 
chapter 1 of the Code, and the regulations thereunder.



Sec. 1.501(c)(7)-1  Social clubs.

    (a) The exemption provided by section 501(a) for organizations 
described in section 501(c)(7) applies only to clubs which are organized 
and operated exclusively for pleasure, recreation, and other 
nonprofitable purposes, but does not apply to any club if any part of 
its net earnings inures to the benefit of any private shareholder. In 
general, this exemption extends to social and

[[Page 24]]

recreation clubs which are supported solely by membership fees, dues, 
and assessments. However, a club otherwise entitled to exemption will 
not be disqualified because it raises revenue from members through the 
use of club facilities or in connection with club activities.
    (b) A club which engages in business, such as making its social and 
recreational facilities available to the general public or by selling 
real estate, timber, or other products, is not organized and operated 
exclusively for pleasure, recreation, and other nonprofitable purposes, 
and is not exempt under section 501(a). Solicitation by advertisement or 
otherwise for public patronage of its facilities is prima facie evidence 
that the club is engaging in business and is not being operated 
exclusively for pleasure, recreation, or social purposes. However, an 
incidental sale of property will not deprive a club of its exemption.



Sec. 1.501(c)(8)-1  Fraternal beneficiary societies.

    (a) A fraternal beneficiary society is exempt from tax only if 
operated under the lodge system or for the exclusive benefit of the 
members so operating. Operating under the lodge system means carrying on 
its activities under a form of organization that comprises local 
branches, chartered by a parent organization and largely self-governing, 
called lodges, chapters, or the like. In order to be exempt it is also 
necessary that the society have an established system for the payment to 
its members or their dependents of life, sick, accident, or other 
benefits.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7061, 35 FR 
14770, Sept. 23, 1970]



Sec. 1.501(c)(9)-1  Voluntary employees' beneficiary associations, in general.

    To be described in section 501(c)(9) an organization must meet all 
of the following requirements:
    (a) The organization is an employees' association,
    (b) Membership in the association is voluntary,
    (c) The organization provides for the payment of life, sick, 
accident, or other benefits to its members or their dependents or 
designated beneficiaries, and substantially all of its operations are in 
furtherance of providing such benefits, and
    (d) No part of the net earnings of the organization inures, other 
than by payment of the benefits referred to in paragraph (c) of this 
section, to the benefit of any private shareholder or individual.

[T.D. 7750, 45 FR 1721, Jan. 7, 1981]



Sec. 1.501(c)(9)-2  Membership in a voluntary employees' beneficiary 

association; employees; voluntary association of employees.

    (a) Membership--(1) In general. The membership of an organization 
described in section 501(c)(9) must consist of individuals who become 
entitled to participate by reason of their being employees and whose 
eligibility for membership is defined by reference to objective 
standards that constitute an employment-related common bond among such 
individuals. Typically, those eligible for membership in an organization 
described in section 501(c)(9) are defined by reference to a common 
employer (or affiliated employers), to coverage under one or more 
collective bargaining agreements (with respect to benefits provided by 
reason of such agreement(s)), to membership in a labor union, or to 
membership in one or more locals of a national or international labor 
union. For example, membership in an association might be open to all 
employees of a particular employer, or to employees in specified job 
classifications working for certain employers at specified locations and 
who are entitled to benefits by reason of one or more collective 
bargaining agreements. In addition, employees of one or more employers 
engaged in the same line of business in the same geographic locale will 
be considered to share an employment-related bond for purposes of an 
organization through which their employers provide benefits. Employees 
of a labor union also will be considered to share an employment-related 
common bond with members of the union, and employees of an association 
will be considered to share an employment-related common bond with 
members of the association. Whether a

[[Page 25]]

group of individuals is defined by reference to a permissible standard 
or standards is a question to be determined with regard to all the facts 
and circumstances, taking into account the guidelines set forth in this 
paragraph. Exemption will not be denied merely because the membership of 
an association includes some individuals who are not employees (within 
the meaning of paragraph (b) of this section), provided that such 
individuals share an employment-related bond with the employee-members. 
Such individuals may include, for example, the proprietor of a business 
whose employees are members of the association. For purposes of the 
preceding two sentences, an association will be considered to be 
composed of employees if 90 percent of the total membership of the 
association on one day of each quarter of the association's taxable year 
consists of employees (within the meaning of paragraph (b) of this 
section).
    (2) Restrictions--(i) In general. Eligibility for membership may be 
restricted by geographic proximity, or by objective conditions or 
limitations reasonably related to employment, such as a limitation to a 
reasonable classification of workers, a limitation based on a reasonable 
minimum period of service, a limitation based on maximum compensation, 
or a requirement that a member be employed on a full-time basis. 
Similarly, eligibility for benefits may be restricted by objective 
conditions relating to the type or amount of benefits offered. Any 
objective criteria used to restrict eligibility for membership or 
benefits may not, however, be selected or administered in a manner that 
limits membership or benefits to officers, shareholders, or highly 
compensated employees of an employer contributing to or otherwise 
funding the employees' association. Similarly, eligibility for benefits 
may not be subject to conditions or limitations that have the effect of 
entitling officers, shareholders, or highly compensated employees of an 
employer contributing to or otherwise funding the employees' association 
to benefits that are disproportionate in relation to benefits to which 
other members of the association are entitled. See Sec. 1.501(c)(9)-
4(b). Whether the selection or administration of objective conditions 
has the effect of providing disproportionate benefits to officers, 
shareholders, or highly compensated employees generally is to be 
determined on the basis of all the facts and circumstances.
    (ii) Generally permissible restrictions or conditions. In general 
the following restrictions will not be considered to be inconsistent 
with Sec. 1.501(c)(9)-2(a)(2)(i) or Sec. 1.501(c)(9)-4(b):
    (A) In the case of an employer-funded organization, a provision that 
excludes or has the effect of excluding from membership in the 
organization or participation in a particular benefit plan employees who 
are members of another organization or covered by a different plan, 
funded or contributed to by the employer, to the extent that such other 
organization or plan offers similar benefits on comparable terms to the 
excluded employees.
    (B) In the case of an employer funded-organization, a provision that 
excludes from membership, or limits the type or amount of benefits 
provided to, individuals who are included in a unit of employees covered 
by an agreement which the Secretary of Labor finds to be a collective 
bargaining agreement between employee representatives and one or more 
employers, if there is evidence that the benefit or benefits provided by 
the organization were the subject of good faith bargaining between such 
employee representatives and such employer or employers.
    (C) Restrictions or conditions on eligibility for membership or 
benefits that are determined through collective bargaining, by trustees 
designated pursuant to a collective bargaining agreement, or by the 
collective bargaining agents of the members of an association or 
trustees named by such agent or agents.
    (D) The allowance of benefits only on condition that a member or 
recipient contribute to the cost of such benefits, or the allowance of 
different benefits based solely on differences in contributions, 
provided that those making equal contributions are entitled to 
comparable benefits.

[[Page 26]]

    (E) A requirement that a member (or a member's dependents) meet a 
reasonable health standard related to eligibility for a particular 
benefit.
    (F) The provision of life benefits in amounts that are a uniform 
percentage of the compensation received by the individual whose life is 
covered.
    (G) The provision of benefits in the nature of wage replacement in 
the event of disability in amounts that are a uniform percentage of the 
compensation of the covered individuals (either before or after taking 
into account any disability benefits provided through social security or 
any similar plan providing for wage replacement in the event of 
disability).
    (3) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. Pursuant to a collective bargaining agreement entered 
into by X Corporation and W, a labor union which represents all of X 
Corporation's hourly-paid employees, the X Corporation Union Benefit 
Plan is established to provide life insurance benefits to employees of X 
represented by W. The Plan is funded by contributions from X, and is 
jointly administered by X and W. In order to provide its non-unionized 
employees with comparable life insurance benefits, X also establishes 
and funds the X Corporation Life Insurance Trust. The Trust will not be 
ineligible for exemption as an organization described in section 
501(c)(9) solely because membership is restricted to those employees of 
X who are not members of W.
    Example 2. The facts are the same as in Example 1 except that the 
life insurance benefit provided to the non-unionized employees of X 
differs from the life insurance benefit provided to the unionized 
employees of X pursuant to the collective bargaining agreement. The 
trust will not be ineligible for exemption as an organization described 
in section 501(c)(9) solely because the life insurance benefit provided 
to X's nonunionized employees is not same as the life insurance benefit 
provided to X's unionized employees.
    Example 3. S corporation established a plan to provide health 
benefits to all its employees. In accordance with the provisions of the 
plan each employee may secure insurance coverage by making an election 
under which the employee agrees to contribute periodically to the plan 
an amount which is determined solely by whether the employee elects a 
high option coverage or a low option coverage and on whether the 
employee is unmarried or has a family. As an alternative, the employee 
may elect high or low options, self only or self and family, coverage 
through a local prepaid group medical plan. The contributions required 
of those electing the prepaid group medical plan also vary with the type 
of coverage selected, and differ from those required of employees 
electing insurance. The difference between the amount contributed by 
employees electing the various coverages and the actual cost of 
purchasing the coverage is made up through contributions by S to the 
plan, and under the plan, S provides approximately the same proportion 
of the cost for each coverage. To fund the plan, S established an 
arrangement in the nature of a trust under applicable local law and 
contributes all employee contributions, and all amounts which by the 
terms of the plan it is required to contribute, to the trust. The terms 
of the plan do not provide for disproportionate benefits to the 
employees of S and will not be considered inconsistent with Sec. 
1.501(c)(9)-2(a)(2)(i).
    Example 4. The facts are the same as in Example 3 except that, for 
those employees or former employees covered by Medicare, the plan 
provides a distinct coverage which supplements Medicare benefits. 
Eligibility for Medicare is an objective condition relating to a type of 
benefit offered, and the provision of separate coverage for those 
eligible for Medicare will not be considered inconsistent with Sec. 
1.501(c)(9)-2(a)(2)(i).

    (b) Meaning of employee. Whether an individual is an employee is 
determined by reference to the legal and bona fide relationship of 
employer and employee. The term employee includes the following:
    (1) An individual who is considered an employee:
    (i) For employment tax purposes under subtitle C of the Internal 
Revenue Code and the regulations thereunder, or
    (ii) For purposes of a collective bargaining agreement,


whether or not the individual could qualify as an employee under 
applicable common law rules. This would include any person who is 
considered an employee for purposes of the Labor Management Relations 
Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 141 (1979).
    (2) An individual who became entitled to membership in the 
association by reason of being or having been an employee. Thus, an 
individual who would otherwise qualify under this paragraph will 
continue to qualify as an employee even though such individual is on 
leave of absence, works temporarily for another employer or as

[[Page 27]]

an independent contractor, or has been terminated by reason of 
retirement, disability or layoff. For example, an individual who in the 
normal course of employment is employed intermittently by more than one 
employer in an industry characterized by short-term employment by 
several different employers will not, by reason of temporary 
unemployment, cease to be an employee within the meaning of this 
paragraph.
    (3) The surviving spouse and dependents of an employee (if, for 
purposes of the 90-percent test of Sec. 1.501(c)(9)-2(a)(1) they are 
considered to be members of the association).
    (c) Description of voluntary association of employees--(1) 
Association. To be described in section 501(c)(9) and this section there 
must be an entity, such as a corporation or trust established under 
applicable local law, having an existence independent of the member-
employees or their employer.
    (2) Voluntary. Generally, membership in an association is voluntary 
if an affirmative act is required on the part of an employee to become a 
member rather than the designation as a member due to employee status. 
However, an association shall be considered voluntary although 
membership is required of all employees, provided that the employees do 
not incur a detriment (for example, in the form of deductions from pay) 
as the result of membership in the association. An employer is not 
deemed to have imposed involuntary membership on the employee if 
membership is required as the result of a collective bargaining 
agreement or as an incident of membership in a labor organization.
    (3) Of employees. To be described in this section, an organization 
must be controlled--
    (i) By its membership,
    (ii) By independent trustee(s) (such as a bank), or
    (iii) By trustees or other fiduciaries at least some of whom are 
designated by, or on behalf of, the membership. Whether control by or on 
behalf of the membership exists is a question to be determined with 
regard to all of the facts and circumstances, but generally such control 
will be deemed to be present when the membership (either directly or 
through its representative) elects, appoints or otherwise designates a 
person or persons to serve as chief operating officer(s), 
administrator(s), or trustee(s) of the organization. For purposes of 
this paragraph an organization will be considered to be controlled by 
independent trustees if it is an employee welfare benefit plan, as 
defined in section 3(1) of the Employee Retirement Income Security Act 
of 1974 (ERISA), and, as such, is subject to the requirements of parts 1 
and 4 of subtitle B, title I of ERISA. Similarly, a plan will be 
considered to be controlled by its membership if it is controlled by one 
or more trustees designated pursuant to a collective bargaining 
agreement (whether or not the bargaining agent of the represented 
employees bargained for and obtained the right to participate in 
selecting the trustees).
    (4) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, a labor union, represents all the hourly-paid 
employees of Y Corporation. A health insurance benefit plan was 
established by X and Y as the result of a collective bargaining 
agreement entered into by them. The plan established the terms and 
conditions of membership in, and the benefits to be provided by, the 
plan. In accordance with the terms of the agreement, Y Corporation is 
obligated to establish a trust fund and make contributions thereto at 
specified rates. The trustees, some of whom are designated by X and some 
by Y, are authorized to hold and invest the assets of the trust and to 
make payments on instructions issued by Y Corporation in accordance with 
the conditions contained in the plan. The interdependent benefit plan 
agreement and trust indenture together create a voluntary employees' 
beneficiary association over which the employees posses the requisite 
control through the trustees designated by their representative, X.
    Example 2. Z Corporation unilaterally established an educational 
benefit plan for its employees. The purpose of the plan is to provide 
payments for job-related educational or training courses, such as 
apprenticeship training programs, for Z Corporation employees, according 
to objective criteria set forth in the plan. Z establishes a separate 
bank account which it uses to fund payments to the plan. Contributions 
to the account are to be made at the discretion of and solely by Z 
Corporation, which also administers the plan and retains control over 
the assets in the fund. Z Corporation's educational benefit

[[Page 28]]

plan and the related account do not constitute an association having an 
existence independent of Z Corporation and therefore do not constitute a 
voluntary employees' beneficiary association.
    Example 3. A, an individual, is the incorporator and chief operating 
officer of Lawyers' Beneficiary Association (LBA). LBA is engaged in the 
business of providing medical benefits to members of the Association and 
their families. Membership is open only to practicing lawyers located in 
a particular metropolitan area who are neither self-employed nor 
partners in a law firm. Membership in LBA is solicited by insurance 
agents under the control of X Corporation (owned by A) which, by 
contract with LBA, is the exclusive sales agent. Medical benefits are 
paid from a trust account containing periodic contributions paid by the 
members, together with proceeds from the investment of those 
contributions. Contribution and benefit levels are set by LBA. The 
members of LBA do not hold meetings, have no right to elect officers or 
directors of the Association, and no right to replace trustees. 
Collectively, the subscribers for medical benefits from LBA cannot be 
said to control the association and membership is neither more than nor 
different from the purchase of an insurance policy from a stock 
insurance company. LBA is not a voluntary employees' beneficiary 
association.
    Example 4. U corporation unilaterally established a plan to provide 
benefits to its employees. In accordance with the provisions of the 
plan, each employee may secure insurance or benefit coverage by making 
an election under which the employee agrees to contribute to the plan an 
amount which is determined solely by whether the employee elects a high 
option coverage or a low option coverage and on whether the employee 
elects self only or self and family coverage. The difference between the 
amount contributed by employees electing the various coverages and the 
actual cost of the coverage is made up through contributions by U to the 
plan. To fund the plan, U established an arrangement in the nature of a 
trust under applicable local law and contributed all employee 
contributions, and all amounts which by the term of the plan it was 
required to provide to the plan, to the trust. The trust constitutes an 
employee welfare benefit plan within the meaning of, and subject to 
relevant requirements of, ERISA. It will be considered to meet the 
requirements of Sec. 1.501(c)(9)-2(c)(3).

[T.D. 7750, 46 FR 1723, Jan. 7, 1981]



Sec. 1.501(c)(9)-3  Voluntary employees' beneficiary associations; life, sick, 

accident, or other benefits.

    (a) In general. The life, sick, accident, or other benefits provided 
by a voluntary employees' beneficiary association must be payable to its 
members, their dependents, or their designated beneficiaries. For 
purposes of section 501(c)(9), dependent means the member's spouse; any 
child of the member or the member's spouse who is a minor or a student 
(within the meaning of section 151(e)(4)); any other minor child 
residing with the member; and any other individual who an association, 
relying on information furnished to it by a member, in good faith 
believes is a person described in section 152(a). Life, sick, accident, 
or other benefits may take the form of cash or noncash benefits. A 
voluntary employees' beneficiary association is not operated for the 
purpose of providing life, sick, accident, or other benefits unless 
substantially all of its operations are in furtherance of the provision 
of such benefits. Further, an organization is not described in this 
section if it systematically and knowingly provides benefits (of more 
than a de minimis amount) that are not permitted by paragraphs (b), (c), 
(d), or (e) of this section.
    (b) Life benefits. The term life benefits means a benefit (including 
a burial benefit or a wreath) payable by reason of the death of a member 
or dependent. A life benefit may be provided directly or through 
insurance. It generally must consist of current protection, but also may 
include a right to convert to individual coverage on termination of 
eligibility for coverage through the association, or a permanent benefit 
as defined in, and subject to the conditions in, the regulations under 
section 79. A life benefit also includes the benefit provided under any 
life insurance contract purchased directly from an employee-funded 
association by a member or provided by such an association to a member. 
The term life benefit does not include a pension, annuity or similar 
benefit, except that a benefit payable by reason of the death of an 
insured may be settled in the form of an annuity to the beneficiary in 
lieu of a lump-sum death benefit (whether or not the contract provides 
for settlement in a lump sum).
    (c) Sick and accident benefits. The term sick and accident benefits 
means amounts furnished to or on behalf of a member or a member's 
dependents in

[[Page 29]]

the event of illness or personal injury to a member or dependent. Such 
benefits may be provided through reimbursement to a member or a member's 
dependents for amounts expended because of illness or personal injury, 
or through the payment of premiums to a medical benefit or health 
insurance program. Similarly, a sick and accident benefit includes an 
amount paid to a member in lieu of income during a period in which the 
member is unable to work due to sickness or injury. Sick benefits also 
include benefits designed to safeguard or improve the health of members 
and their dependents. Sick and accident benefits may be provided 
directly by an association to or on behalf of members and their 
dependents, or may be provided indirectly by an association through the 
payment of premiums or fees to an insurance company, medical clinic, or 
other program under which members and their dependents are entitled to 
medical services or to other sick and accident benefits. Sick and 
accident benefits may also be furnished in noncash form, such as, for 
example, benefits in the nature of clinical care services by visiting 
nurses, and transportation furnished for medical care.
    (d) Other benefits. The term other benefits includes only benefits 
that are similar to life, sick, or accident benefits. A benefit is 
similar to a life, sick, or accident benefit if:
    (1) It is intended to safeguard or improve the health of a member or 
a member's dependents, or
    (2) It protects against a contingency that interrupts or impairs a 
member's earning power.
    (e) Examples of other benefits. Paying vacation benefits, providing 
vacation facilities, reimbursing vacation expenses, and subsidizing 
recreational activities such as athletic leagues are considered other 
benefits. The provision of child-care facilities for preschool and 
school-age dependents are also considered other benefits. The provision 
of job readjustment allowances, income maintenance payments in the event 
of economic dislocation, temporary living expense loans and grants at 
times of disaster (such as fire or flood), supplemental unemployment 
compensation benefits (as defined in section 501(c)(17)(D)(i) of the 
Code), severance benefits (under a severance pay plan within the meaning 
of 29 CFR 2510.3-2(b)) and education or training benefits or courses 
(such as apprentice training programs) for members, are considered other 
benefits because they protect against a contingency that interrupts 
earning power. Personal legal service benefits which consist of payments 
or credits to one or more organizations or trusts described in section 
501(c)(20) are considered other benefits. Except to the extent otherwise 
provided in these regulations, as amended from time to time, other 
benefits also include any benefit provided in the manner permitted by 
paragraphs (5) et seq. of section 302(c) of the Labor Management 
Relations Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 186(c) 
(1979).
    (f) Examples of nonqualifying benefits. Benefits that are not 
described in paragraphs (d) or (e) of this section are not other 
benefits. Thus, other benefits do not include the payment of commuting 
expenses, such as bridge tolls or train fares, the provision of accident 
or homeowner's insurance benefits for damage to property, the provision 
of malpractice insurance, or the provision of loans to members except in 
times of distress (as permitted by Sec. 1.501(c)(9)-3(e)). Other 
benefits also do not include the provision of savings facilities for 
members. The term other benefits does not include any benefit that is 
similar to a pension or annuity payable at the time of mandatory or 
voluntary retirement, or a benefit that is similar to the benefit 
provided under a stock bonus or profit-sharing plan. For purposes of 
section 501(c)(9) and these regulations, a benefit will be considered 
similar to that provided under a pension, annuity, stock bonus or 
profit-sharing plan if it provides for deferred compensation that 
becomes payable by reason of the passage of time, rather than as the 
result of an unanticipated event. Thus, for example, supplemental 
unemployment benefits, which generally become payable by reason of 
unanticipated layoff, are not, for purposes of these regulations, 
considered similar to the benefit provided under a pension, annuity, 
stock bonus or profit-sharing plan.

[[Page 30]]

    (g) Examples. The provisions of this section may be further 
illustrated by the following examples:

    Example 1. V was organized in connection with a vacation plan 
created pursuant to a collective bargaining agreement between M, a labor 
union, which represents certain hourly paid employees of T corporation, 
and T. The agreement calls for the payment by T to V of a specified sum 
per hour worked by T employees who are covered by the collective 
bargaining agreement. T includes the amounts in the covered employees' 
wages and withholds income and FICA taxes. The amounts are paid by T to 
V to provide vacation benefits provided under the collective bargaining 
agreement. Generally, each covered employee receives a check in payment 
of his or her vacation benefit during the year following the year in 
which contributions were made by T to V. The amount of the vacation 
benefit is determined by reference to the contributions during the prior 
year to V by T on behalf of each employee, and is distributed in cash to 
each such employee. If the earnings on investments by V during the year 
preceding distribution are sufficient after deducting the expenses of 
administering the plan, each recipient of a vacation benefit is paid an 
amount, in addition to the contributions on his or her behalf, equal to 
his/her ratable share of the net earnings of V during such year. The 
plan provides a vacation benefit that constitutes an eligible other 
benefit described in section 501(c)(9) and Sec. 1.501(c)(9)-3(e).
    Example 2. The facts are the same as in Example 1, except that each 
covered employee of T is entitled, at his or her discretion, to 
contribute up to an additional $1,000 each year to V, which agrees in 
respect of such sum to pay interest at a stated rate from the time of 
contribution until the time at which the contributing employee's 
vacation benefit is distributed. In addition, each employee may elect to 
leave all or a portion of his/her distributable benefit on deposit past 
the time of distribution, in which case interest will continue to 
accrue. Because the plan more closely resembles a savings arrangement 
than a vacation plan, the benefit payable to the covered employees of T 
is not a vacation benefit and is not an eligible other benefit described 
in section 501(c)(9) and Sec. 1.501(c)(9)-3 (d) or (e).

[T.D. 7750, 46 FR 1724, Jan. 7, 1981]



Sec. 1.501(c)(9)-4  Voluntary employees' beneficiary associations; inurement.

    (a) General rule. No part of the net earnings of an employees' 
association may inure to the benefit of any private shareholder or 
individual other than through the payment of benefits permitted by Sec. 
1.501(c)(9)-3. The disposition of property to, or the performance of 
services for, a person for less than the greater of fair market value or 
cost (including indirect costs) to the association, other than as a 
life, sick, accident or other permissible benefit, constitutes 
prohibited inurement. Generally, the payment of unreasonable 
compensation to the trustees or employees of the association, or the 
purchase of insurance or services for amounts in excess of their fair 
market value from a company in which one or more of the association's 
trustees, officers or fiduciaries has an interest, will constitute 
prohibited inurement. Whether prohibited inurement has occurred is a 
question to be determined with regard to all of the facts and 
circumstances, taking into account the guidelines set forth in this 
section. The guidelines and examples contained in this section are not 
an exhaustive list of the activities that may constitute prohibited 
inurement, or the persons to whom the association's earnings could 
impermissibly inure. See Sec. 1.501(a)-1(c).
    (b) Disproportionate benefits. For purposes of subsection (a), the 
payment to any member of disproportionate benefits, where such payment 
is not pursuant to objective and nondiscriminatory standards, will not 
be considered a benefit within the meaning of Sec. 1.501(c)(9)-3 even 
though the benefit otherwise is one of the type permitted by that 
section. For example, the payment to highly compensated personnel of 
benefits that are disproportionate in relation to benefits received by 
other members of the association will constitute prohibited inurement. 
Also, the payment to similarly situated employees of benefits that 
differ in kind or amount will constitute prohibited inurement unless the 
difference can be justified on the basis of objective and reasonable 
standards adopted by the association or on the basis of standards 
adopted pursuant to the terms of a collective bargaining agreement. In 
general, benefits paid pursuant to standards or subject to conditions 
that do not provide for disproportionate benefits to officers, 
shareholders, or highly compensated employees will not be considered 
disproportionate. See Sec. 1.501(c)(9)-2(a) (2) and (3).

[[Page 31]]

    (c) Rebates. The rebate of excess insurance premiums, based on the 
mortality or morbidity experience of the insurer to which the premiums 
were paid, to the person or persons whose contributions were applied to 
such premiums, does not constitute prohibited inurement. A voluntary 
employees' beneficiary association may also make administrative 
adjustments strictly incidental to the provision of benefits to its 
members.
    (d) Termination of plan or dissolution of association. It will not 
constitute prohibited inurement if, on termination of a plan established 
by an employer and funded through an association described in section 
501(c)(9), any assets remaining in the association, after satisfaction 
of all liabilities to existing beneficiaries of the plan, are applied to 
provide, either directly or through the purchase of insurance, life, 
sick, accident or other benefits within the meaning of Sec. 
1.501(c)(9)-3 pursuant to criteria that do not provide for 
disproportionate benefits to officers, shareholders, or highly 
compensated employees of the employer. See Sec. 1.501(c)(9)-2(a)(2). 
Similarly, a distribution to members upon the dissolution of the 
association will not constitute prohibited inurement if the amount 
distributed to members are determined pursuant to the terms of a 
collective bargaining agreement or on the basis of objective and 
reasonable standards which do not result in either unequal payments to 
similarly situated members or in disproportionate payments to officers, 
shareholders, or highly compensated employees of an employer 
contributing to or otherwise funding the employees' association. Except 
as otherwise provided in the first sentence of this paragraph, if the 
association's corporate charter, articles of association, trust 
instrument, or other written instrument by which the association was 
created, as amended from time to time, provides that on dissolution its 
assets will be distributed to its members' contributing employers, or if 
in the absence of such provision the law of the state in which the 
association was created provides for such distribution to the 
contributing employers, the association is not described in section 
501(c)(9).
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. Employees A, B and C, members of the X voluntary employees' 
beneficiary association, are unemployed. They receive unemployment 
benefits from X. Those to A include an amount in addition to those 
provided to B and C, to provide for A's retraining. B has been found 
pursuant to objective and reasonable standards not to qualify for the 
retraining program. C, although eligible for retraining benefits has 
declined. X's additional payment to A for retraining does not constitute 
prohibited inurement.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec. 1.501(c)(9)-5  Voluntary employees' beneficiary associations; 

recordkeeping requirements.

    (a) Records. In addition to such other records which may be required 
(for example, by section 512(a)(3) and the regulations thereunder), 
every organization described in section 501(c)(9) must maintain records 
indicating the amount contributed by each member and contributing 
employer, and the amount and type of benefits paid by the organization 
to or on behalf of each member.
    (b) Cross reference. For provisions relating to annual information 
returns with respect to payments, see section 6041 and the regulations 
thereunder.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec. 1.501(c)(9)-6  Voluntary employees' beneficiary associations; benefits 

includible in gross income.

    (a) In general. Cash and noncash benefits realized by a person on 
account of the activities of an organization described in section 
501(c)(9) shall be included in gross income to the extent provided in 
the Internal Revenue Code of 1954, including, but not limited to, 
sections 61, 72, 101, 104 and 105 of the Code and regulations 
thereunder.
    (b) Availability of statutory exclusions from gross income. The 
availability of any statutory exclusion from gross income with respect 
to contributions to, or the payment of benefits from, an organization 
described in section 501(c)(9) is determined by the statutory provision 
conferring the exclusion, and the regulations and rulings thereunder, 
not by whether an individual is eligible for

[[Page 32]]

membership in the organization or by the permissibility of the benefit 
paid. Thus, for example, if a benefit is paid by an employer-funded 
organization described in section 501(c)(9) to a member who is not an 
employee, a statutory exclusion from gross income that is available only 
for employees would be unavailable in the case of a benefit paid to such 
individual. Similarly, the fact that, for example, under some 
circumstances educational benefits constitute other benefits does not of 
itself mean that such benefits are eligible for the exclusion of either 
section 117 or section 127 of the Code.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec. 1.501(c)(9)-7  Voluntary employees' beneficiary associations; section 

3(4) of ERISA.

    The term voluntary employees' beneficiary association in section 
501(c)(9) of the Internal Revenue Code is not necessarily coextensive 
with the term employees' beneficiary association as used in section 3(4) 
of the Employee Retirement Income Security Act of 1974 (ERISA), 29 
U.S.C. 1002(4), and the requirements which an organization must meet to 
be an employees' beneficiary association within the meaning of section 
3(4) of ERISA are not necessarily identical to the requirements that an 
organization must meet in order to be a voluntary employees' beneficiary 
association within the meaning of section 501(c)(9) of the Code.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec. 1.501(c)(9)-8  Voluntary employees' beneficiary associations; effective 

date.

    (a) General rule. Except as otherwise provided in this section, the 
provisions of Sec. Sec. 1.501(c)(9)-1 through 1.501(c)(9)-7 shall apply 
with respect to taxable years beginning after December 31, 1954.
    (b) Pre-1970 taxable years. For taxable years beginning before 
January 1, 1970, section 501(c)(9)(B) (relating to the requirement that 
85 percent or more of the association's income consist of amounts 
collected from members and contributed by employers), as in effect for 
such years, shall apply.
    (c) Existing associations. Except as otherwise provided in paragraph 
(d), the provisions of Sec. 1.501(c)(9)-2(a)(1) and (c)(3) shall apply 
with respect to taxable years beginning after December 31, 1980.
    (d) Collectively-bargained plans. In the case of a voluntary 
employees' beneficiary association which receives contributions from one 
or more employers pursuant to one or more collective bargaining 
agreements in effect on December 31, 1980, the provisions of Sec. Sec. 
1.501(c)(9)-1 through 1.501(c)(9)-5 shall apply with respect to taxable 
years beginning after the date on which the agreement terminates 
(determined without regard to any extension thereof agreed to after 
December 31, 1980).
    (e) Election. Notwithstanding paragraphs (c) and (d) of this 
section, an organization may choose to be subject to all or a portion of 
one or more of the provisions of these regulations for any taxable year 
beginning after December 31, 1954.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981; 46 FR 11971, Feb. 12, 1981]



Sec. 1.501(c)(10)-1  Certain fraternal beneficiary societies.

    (a) For taxable years beginning after December 31, 1969, an 
organization will qualify for exemption under section 501(c)(10) if it:
    (1) Is a domestic fraternal beneficiary society order, or 
association, described in section 501(c)(8) and the regulations 
thereunder except that it does not provide for the payment of life, 
sick, accident, or other benefits to its members, and
    (2) Devotes its net earnings exclusively to religious, charitable, 
scientific, literary, educational, and fraternal purposes


Any organization described in section 501(c)(7), such as, for example, a 
national college fraternity, is not described in section 501(c)(10) and 
this section.

[T.D. 7172, 37 FR 5618, Mar. 17, 1972]



Sec. 1.501(c)(12)-1  Local benevolent life insurance associations, mutual 

irrigation and telephone companies, and like organizations.

    (a) An organization described in section 501(c)(12) must receive at 
least 85 percent of its income from amounts

[[Page 33]]

collected from members for the sole purpose of meeting losses and 
expenses. If an organization issues policies for stipulated cash 
premiums, or if it requires advance deposits to cover the cost of the 
insurance and maintains investments from which more than 15 percent of 
its income is derived, it is not entitled to exemption. On the other 
hand, an organization may be entitled to exemption, although it makes 
advance assessments for the sole purpose of meeting future losses and 
expenses, provided that the balance of such assessments remaining on 
hand at the end of the year is retained to meet losses and expenses or 
is returned to members.
    (b) The phrase of a purely local character applies to benevolent 
life insurance associations, and not to the other organizations 
specified in section 501(c)(12). It also applies to any organization 
seeking exemption on the ground that it is an organization similar to a 
benevolent life insurance association. An organization of a purely local 
character is one whose business activities are confined to a particular 
community, place, or district, irrespective, however, of political 
subdivisions. If the activities of an organization are limited only by 
the borders of a State it cannot be considered to be purely local in 
character.
    (c) For taxable years of a mutual or cooperative telephone company 
beginning after December 31, 1974, the 85 percent member-income test 
described in paragraph (a) of this section is applied without taking 
into account income received or accrued from another telephone company 
for the performance of communication services involving the completion 
of long distance calls to, from, or between members of the mutual or 
cooperative telephone company. For example, if, in one year, a 
cooperative telephone company receives $85x from its members for 
telephone calls, $15x as interest income, and $20x as credits under long 
distance interconnection agreements with other telephone companies for 
the performance of communication services involving the completion of 
long distance calls to, from, or between the cooperative's members 
(whether or not the credits may be offset, in whole or in part, by 
amounts due the other companies under the interconnection agreements), 
the member-income fraction is calculated without taking into account, 
either in the numerator or denominator, the $20x credits received from 
the other telephone companies. In this example, the 85 percent member-
income test is satisfied because at least 85 percent
[GRAPHIC] [TIFF OMITTED] TC14NO91.158


of the cooperative's total income is derived from member income.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended at 44 FR 59523, Oct. 16, 1979]



Sec. 1.501(c)(13)-1  Cemetery companies and crematoria.

    (a) Nonprofit mutual cemetery companies. A nonprofit cemetery 
company may be entitled to exemption if it is owned by and operated 
exclusively for the benefit of its lot owners who hold such lots for 
bona fide burial purposes and not for the purpose of fesale. A mutual 
cemetery company which also engages in charitable activities, such as 
burial of paupers, will be regarded as operating in conformity with this 
standard. Further, the fact that a mutual cemetery company limits its 
membership to a particular class of individuals, such as members of a 
family, will not affect its status as mutual so long as all the other 
requirements of section 501(c)(13) are met.
    (b) Nonprofit cemetery companies and crematoria. Any nonprofit 
corporation, chartered solely for the purpose of the burial, or (for 
taxable years beginning after December 31, 1970) the cremation of 
bodies, and not permitted by its charter to engage in any business not 
necessarily incident to that purpose, is exempt from income tax, 
provided that no part of its net earnings inures to the benefit of any 
private shareholder or individual.
    (c) Preferred stock--(1) In general. Except as provided in 
subparagraph (3) of this paragraph, a cemetery company or crematorium is 
not described in section 501(c)(13) if it issues preferred stock on or 
after November 28, 1978.

[[Page 34]]

    (2) Transitional rule for preferred stock issued prior to November 
28, 1978. In the case of preferred stock issued prior to November 28, 
1978, a cemetery company or crematorium which issued such stock shall 
not fail to be exempt from income tax solely because it issued preferred 
stock which entitled the holders to dividends at a fixed rate, not 
exceeding the legal rage of interest in the State of incorporation or 8 
percent per annum, whichever is greater, on the value of the 
consideration for which the stock was issued, if its articles of 
incorporation require:
    (i) That the preferred stock be retired at par as rapidly as funds 
therefor become available from operations, and
    (ii) That all funds not required for the payment of dividends upon 
or for the retirement of preferred stock be used by the company for the 
care and inprovement of the cemetery property. The term legal rate of 
interest shall mean the rate of interest prescribed by law in the State 
of incorporation which prevails in the absence of an agreement between 
contracting parties fixing a rate.
    (3) Transitional rule for preferred stock issued on or after 
November 28, 1978. In the case of preferred stok issued on or after 
November 28, 1978, a cemetery company or crematorium shall not fail to 
be exempt from income tax if its articles of incorporation and the 
preferred stock meet the requirements of paragraph (c)(2) and if such 
stock is issued pursuant to a plan which has been reduced to writing and 
adopted prior to November 28, 1978. The adoption of the plan must be 
shown by the acts of the duly constituted responsible officers and 
appear upon the official records of the cemetery company or crematorium.
    (d) Sales to exempt cemetery companies and crematoria. Except as 
provided in paragraph (c)(2) or (c)(3) of this section (relating to 
transitional rules for preferred stock), no person may have any interest 
in the net earnings of a tax-exempt cemetery company or crematorium. 
Thus, a cemetery company or crematorium is not exempt from tax if 
property is transferred to such organization in exchange for an interest 
in the net earnings of the organization so long as such interest remains 
outstanding. An interest in a cemetery company or crematorium that 
constitutes an equity interest within the meaning of section 385 will be 
considered an interest in the net earnings of the cemetery. However, an 
interest in a cemetery company or crematorium that does not constitute 
an equity interest within the meaning of section 385 may nevertheless 
constitute an interest in the net earning of the organization. Thus, for 
example, a bond or other evidence of indebtedness issued by a cemetery 
company or crematorium which provides for a fixed rate of interest but 
which, in addition, provides for additional interest payments contingent 
upon the revenues or income of the organization is considered an 
interest in the net earnings of the organization. Similarly, a 
convertible debt obligation issued by a cemetery company or crematorium 
after July 7, 1975, is considered an interest in the net earnings of the 
organization.

[T.D. 7698, 45 FR 33972, May 21, 1980]



Sec. 1.501(c)(14)-1  Credit unions and mutual insurance funds.

    Credit unions (other than Federal credit unions described in section 
501(c)(1)) without capital stock, organized and operated for mutual 
purposes and without profit, are exempt from tax under section 501(a). 
Corporations or associations without capital stock organized before 
September 1, 1951 and operated for mutual purposes and without profit 
for the purpose of providing reserve funds for, and insurance of, shares 
or deposits in:
    (a) Domestic building and loan associations as defined in section 
7701(a)(19),
    (b) Cooperative banks without capital stock organized and operated 
for mutual purposes and without profit, or
    (c) Mutual savings banks not having capital stock represented by 
shares


are also exempt from tax under section 501(a). In addition, corporations 
or associations of the type described in the preceding sentence which 
were organized on or after September 1, 1951, but before September 1, 
1957, are exempt

[[Page 35]]

from tax under section 501(a) for taxable years beginning after December 
31, 1959.

[T.D. 6493, 25 FR 9219, Sept. 27, 1960]



Sec. 1.501(c)(15)-1  Mutual insurance companies or associations.

    (a) Taxable years beginning after December 31, 1962. An insurance 
company or association described in section 501(c)(15) is exempt under 
section 501(a) if it is a mutual company or association (other than life 
or marine) or if it is a mutual interinsurer or reciprocal underwriter 
(other than life or marine) and if the gross amount received during the 
taxable year from the sum of the following items does not exceed 
$150,000:
    (1) The gross amount of income during the taxable year from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 822(d)(2) and the regulations thereunder.
    (ii) Dividends, as described in Sec. 1.61-9.
    (iii) Rents and royalties, as described in Sec. 1.61-8.
    (iv) The entering into of any lease, mortgage, or other instrument 
or agreement from which the company may derive interest, rents, or 
royalties.
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by the company or association, or by a 
partnership of which the company or association is a partner.
    (3) Premiums (including deposits and assessments).
    (b) Taxable years beginning after December 31, 1954, and before 
January 1, 1963. An insurance company or association described in 
section 501(c)(15) and paragraph (a) of this section is exempt under 
section 501(a) if the gross amount received during the taxable year from 
the sum of the items described in paragraph (a) (1), (2), and (3) of 
this section does not exceed $75,000.
    (c) No double inclusion of income. In computing the gross income 
from any trade or business (other than an insurance business) carried on 
by the company or association, or by a partnership of which the company 
or association is a partner, any item described in section 822(b)(1) 
(A), (B), or (C) and paragraph (a)(1) of this section shall not be 
considered as gross income arising from the conduct of such trade or 
business, but shall be taken into account under section 822(b)(1) (A), 
(B), or (C) and paragraph (a)(1) of this section.
    (d) Taxable years beginning after December 31, 1953, and before 
January 1, 1955. An insurance company or association described in 
section 501(c)(15) is exempt under section 501(a) if it is a mutual 
company or association (other than life or marine) or if it is a mutual 
interinsurer or reciprocal underwriter (other than life or marine) and 
if the gross amount received during the taxable year from the sum of the 
following items does not exceed $75,000:
    (1) The gross amount of income during the taxable year from--
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 822(d)(2) and Sec. 1.822-3.
    (ii) Dividends, as described in Sec. 1.61-9.
    (iii) Rents (but excluding royalties), as described in Sec. 1.61-8.
    (2) Premiums (including deposits and assessments).
    (e) Exclusion of capital gains. Gains from sales or exchanges of 
capital assets to the extent provided in subchapter P (section 1201 and 
following, relating to capital gains and losses), chapter 1 of the Code, 
shall be excluded from the amounts described in this section.

[T.D. 6662, 28 FR 6972, July 29, 1963]



Sec. 1.501(c)(16)-1  Corporations organized to finance crop operations.

    A corporation organized by a farmers' cooperative marketing or 
purchasing association, or the members thereof, for the purpose of 
financing the ordinary crop operations of such members or other 
producers is exempt, provided the marketing or purchasing

[[Page 36]]

association is exempt under section 521 and the financing corporation is 
operated in conjunction with the marketing or purchasing association. 
The provisions of Sec. 1.521-1 relating to a reserve or surplus and to 
capital stock shall also apply to corporations coming under this 
section.



Sec. 1.501(c)(17)-1  Supplemental unemployment benefit trusts.

    (a) Requirements for qualification. (1) A supplemental unemployment 
benefit trust may be exempt as an organization described in section 
501(c)(17) if the requirements of subparagraphs (2) through (6) of this 
paragraph are satisfied.
    (2) The trust is a valid, existing trust under local law and is 
evidenced by an executed written document.
    (3) The trust is part of a written plan established and maintained 
by an employer, his employees, or both the employer and his employees, 
solely for the purpose of providing supplemental unemployment 
compensation benefits (as defined in section 501(c)(17)(D) and paragraph 
(b)(1) of Sec. 1.501(c)(17)-1).
    (4) The trust is part of a plan which provides that the corpus and 
income of the trust cannot (in the taxable year, and at any time 
thereafter, before the satisfaction of all liabilities to employees 
covered by the plan) be used for, or diverted to, any purpose other than 
the providing of supplemental unemployment compensation benefits. Thus, 
if the plan provides for the payment of any benefits other than 
supplemental unemployment compensation benefits as defined in paragraph 
(b) of this section, the trust will not be entitled to exemption as an 
organization described in section 501(c)(17). However, the payment of 
any necessary or appropriate expenses in connection with the 
administration of a plan providing supplemental unemployment 
compensation benefits shall be considered a payment to provide such 
benefits and shall not affect the qualification of the trust.
    (5) The trust is part of a plan whose eligibility conditions and 
benefits do not discriminate in favor of employees who are officers, 
shareholders, persons whose principal duties consist of supervising the 
work of other employees, or highly compensated employees. See sections 
401(a)(3)(B) and 401(a)(4) and Sec. Sec. 1.401-3 and 1.401-4. However, 
a plan is not discriminatory within the meaning of section 
501(c)(17)(A)(iii), relating to the requirement that the benefits paid 
under the plan be nondiscriminatory, merely because the benefits 
received under the plan bear a uniform relationship to the total 
compensation, or the basic or regular rate of compensation, of the 
employees covered by the plan. Accordingly, the benefits provided for 
highly paid employees may be greater than the benefits provided for 
lower paid employees if the benefits are determined by reference to 
their compensation; but, in such a case, the plan will not qualify if 
the benefits paid to the higher paid employees bear a larger ratio to 
their compensation than the benefits paid to the lower paid employees 
bear to their compensation. In addition, section 501(c)(17)(B) sets 
forth certain other instances in which a plan will not be considered 
discriminatory (see paragraph (c) of Sec. 1.501(c)(17)-2).
    (6) The trust is part of a plan which requires that benefits are to 
be determined according to objective standards. Thus, a plan may provide 
similarly situated employees with benefits which differ in kind and 
amount, but may not permit such benefits to be determined solely in the 
discretion of the trustees.
    (b) Meaning of terms. The following terms are defined for purposes 
of section 501(c)(17):
    (1) Supplemental unemployment compensation benefits. The term 
supplemental unemployment compensation benefits means only:
    (i) Benefits paid to an employee because of his involuntary 
separation from the employment of the employer, whether or not such 
separation is temporary, but only when such separation is one resulting 
directly from a reduction in force, the discontinuance of a plant or 
operation, or other similar conditions; and
    (ii) Sick and accident benefits subordinate to the benefits 
described in subdivision (i) of this subparagraph.
    (2) Employee. The term employee means an individual whose status is 
that of an employee under the usual

[[Page 37]]

common-law rules applicable in determining the employer-employee 
relationship. The term employee also includes an individual who 
qualifies as an employee under the State or Federal unemployment 
compensation law covering his employment, whether or not such an 
individual could qualify as an employee under such common-law rules.
    (3) Involuntary separation from the employment of the employer. 
Whether a separation from the employment of the employer occurs is a 
question to be decided with regard to all the facts and circumstances. 
However, for purposes of section 501(c)(17), the term separation 
includes both a temporary separation and a permanent severance of the 
employment relationship. Thus, for example, an employee may be separated 
from the employment of his employer even though at the time of 
separation it is believed that he will be reemployed by the same 
employer. Whether or not an employee is involuntarily separated from the 
employment of the employer is a question of fact. However, normally, an 
employee will not be deemed to have separated himself voluntarily from 
the employment of his employer merely because his collective bargaining 
agreement provides for the termination of his services upon the 
happening of a condition subsequent and that condition does in fact 
occur. For example, if the collective bargaining agreement provides that 
the employer may automate a given department and thereby dislocate 
several employees, the fact that the employees' collective bargaining 
agent has consented to such a condition will not render any employee's 
subsequent unemployment for such cause voluntary.
    (4) Other similar conditions. Involuntary separation directly 
resulting from other similar conditions includes, for example, 
involuntary separation from the employment of the employer resulting 
from cyclical, seasonal, or technological causes. Some causes of 
involuntary separation from the employment of the employer which are not 
similar to those enumerated in section 501(c)(17)(D)(i) are separation 
for disciplinary reasons or separation because of age.
    (5) Subordinate sick and accident benefits. In general, a sick and 
accident benefit payment is an amount paid to an employee in the event 
of his illness or personal injury (whether or not such illness or injury 
results in the employee's separation from the service of his employer). 
In addition, the phrase sick and accident benefits includes amounts 
provided under the plan to reimburse an employee for amounts he expends 
because of the illness or injury of his spouse or a dependent (as 
defined in section 152). Sick and accident benefits may be paid by a 
trust described in section 501(c)(17) only if such benefits are 
subordinate to the separation payments provided under the plan of which 
the trust forms a part. Whether the sick and accident benefits provided 
under a supplemental unemployment compensation benefit plan are 
subordinate to the separation benefits provided under such plan is a 
question to be decided with regard to all the facts and circumstances.

[T.D. 6972, 33 FR 12900, Sept. 12, 1968]



Sec. 1.501(c)(17)-2  General rules.

    (a) Supplemental unemployment compensation benefits. Supplemental 
unemployment compensation benefits as defined in section 501(c)(17)(D) 
and paragraph (b)(1) of Sec. 1.501(c)(17)-1 may be paid in a lump sum 
or installments. Such benefits may be paid to an employee who has, 
subsequent to his separation from the employment of the employer, 
obtained other part-time, temporary, or permanent employment. 
Furthermore, such payments may be made in cash, services, or property. 
Thus, supplemental unemployment compensation benefits provided to 
involuntarily separated employees may include, for example, the 
following: Furnishing of medical care at an established clinic, 
furnishing of food, job training and schooling, and job counseling. If 
such benefits are furnished in services or property, the fair market 
value of the benefits must satisfy the requirements of section 
501(c)(17)(A)(iii), relating to nondiscrimination as to benefits. 
However, supplemental unemployment compensation benefits may be provided 
only to an employee and only under circumstances described in paragraph

[[Page 38]]

(b)(1) of Sec. 1.501(c)(17)-1. Thus, a trust described in section 
501(c)(17) may not provide, for example, for the payment of a death, 
vacation, or retirement benefit.
    (b) Sick and accident benefits. If a trust described in section 
501(c)(17) provides for the payment of sick and accident benefits, such 
benefits may only be provided for employees who are eligible for receipt 
of separation benefits under the plan of which the trust is a part. 
However, the sick and accident benefits need not be provided for all the 
employees who are eligible for receipt of separation benefits, so long 
as the plan does not discriminate in favor of persons with respect to 
whom discrimination is proscribed in section 501(c)(17)(A) (ii) and 
(iii). Furthermore, the portion of the plan which provides for the 
payment of sick and accident benefits must satisfy the nondiscrimination 
requirements of section 501(c)(17)(A) (ii) and (iii) without regard to 
the portion of the plan which provides for the payment of benefits 
because of involuntary separation.
    (c) Correlation with other plans. (1) In determining whether a plan 
meets the requirements of section 501(c)(17)(A) (ii) and (iii), any 
benefits provided under any other plan shall not be taken into 
consideration except in the particular instances enumerated in section 
501(c)(17)(B) (i), (ii), and (iii). In general, these three exceptions 
permit a plan providing for the payment of supplemental unemployment 
compensation benefits to satisfy the nondiscrimination requirements in 
section 501(c)(17)(A) (ii) and (iii) if the plan is able to satisfy such 
requirements when it is correlated with one or more of the plans 
described in section 501(c)(17)(B).
    (2) Under section 501(c)(17)(B)(i), a plan will not be considered 
discriminatory merely because the benefits under the plan which are 
first determined in a nondiscriminatory manner (within the meaning of 
section 501(c)(17)(A)) are then reduced by any sick, accident, or 
unemployment compensation benefits received under State or Federal law, 
or are reduced by a portion of these benefits if determined in a 
nondiscriminatory manner. Under this exception, a plan may, for example, 
satisfy the requirements of section 501(c)(17)(A)(iii) if it provides 
for the payment of an unemployment benefit and the amount of such 
benefit is determined as a percentage of the employee's compensation 
which is then reduced by any unemployment benefit which the employee 
receives under a State plan. In addition, a plan could provide for the 
reduction of such a plan benefit by a percentage of the State benefit. 
Furthermore, a plan may also satisfy the requirements of section 
501(c)(17)(A) if it provides for the payment to an employee of an amount 
which when added to any State unemployment benefit equals a percentage 
of the employee's compensation.
    (3) Under section 501(c)(17)(B)(ii), a plan will not be considered 
discriminatory merely because the plan provides benefits only for 
employees who are not eligible to receive sick, accident, or 
unemployment compensation benefits under State or Federal law. In such a 
case, however, the benefits provided under the plan seeking to satisfy 
the requirements of section 501(c)(17) must be the same benefits, or a 
portion of the same benefits if determined in a nondiscriminatory 
manner, which such ineligible employees would receive under State or 
Federal law if they were eligible for such benefits. Under this 
exception, for example, an employer may establish a plan only for 
employees who have exhausted their benefits under the State law, and, if 
the plan provides for such employees the same benefits which they would 
receive under the State plan, the State plan and the plan of the 
employer will be considered as one plan in determining whether the 
requirements relating to nondiscrimination in section 501(c)(17)(A) are 
satisfied. Furthermore, such a plan could also qualify even though it 
does not provide all of the benefits provided under the State plan. 
Thus, a plan could provide for the payment of a reduced amount of the 
benefits, or for the payment of only certain of the types of benefits, 
provided by the State plan. For example, if the State plan provides for 
the payment of sick, accident, and separation benefits, the plan of the 
employer may provide for the payment of only separation benefits, or for 
the payment of an amount

[[Page 39]]

equal to only one-half of the State provided benefit. However, if a plan 
provides benefits for employees who are not eligible to receive the 
benefits provided under a State plan and such benefits are greater or of 
a different type than those under the State plan, the plan of the 
employer must satisfy the requirements of section 501(c)(17)(A) without 
regard to the benefits and coverage provided by the State plan.
    (4) Under section 501(c)(17)(B)(iii), a plan is not considered 
discriminatory merely because the plan provides benefits only for 
employees who are not eligible to receive benefits under another plan 
which satisfies the requirements of section 501(c)(17)(A) and which is 
funded solely by contributions of the employer. In such a case, the plan 
seeking to qualify under section 501(c)(17) must provide the same 
benefits, or a portion of such benefits if determined in a 
nondiscriminatory manner, as are provided for the employees under the 
plan funded solely by employer contributions. Furthermore, this 
exception only applies if the employees eligible to receive benefits 
under both plans would satisfy the requirements in section 
501(c)(17)(A)(ii), relating to nondiscrimination as to coverage. The 
plan of the employer which is being correlated with the plan seeking to 
satisfy the requirements of section 501(c)(17) may be a plan which forms 
part of a voluntary employees' beneficiary association described in 
section 501(c)(9), if such plan satisfies all the requirements of 
section 501(c)(17)(A). Under this exception, for example, if an employer 
has established a plan providing for the payment of supplemental 
unemployment compensation benefits for his hourly wage employees and 
such plan satisfies the requirements of section 501(c)(17)(A) (even 
though the plan forms part of a voluntary employees' beneficiary 
association described in section 501(c)(9)), the salaried employees of 
such employee may establish a plan for themselves, and, if such plan 
provides for the same benefits as the plan covering hourly-wage 
employees, both plans may be considered as one plan in determining 
whether the plan covering the salaried employees satisfies the 
requirement that is be nondiscriminatory as to coverage. The foregoing 
example would also be applicable if the benefits provided for the 
salaried employees were funded solely or in part by employer 
contributions.
    (d) Permanency of the plan. A plan providing for the payment of 
supplemental unemployment compensation benefits contemplates a permanent 
as distinguished from a temporary program. Thus, although there may be 
reserved the right to change or terminate the plan, and to discontinue 
contributions thereunder, the abandonment of the plan for any reason 
other than business necessity within a few years after it has taken 
effect will be evidence that the plan from its inception was not a bona 
fide program for the purpose of providing supplemental unemployment 
compensation benefits to employees. Whether or not a particular plan 
constitutes a permanent arrangement will be determined by all of the 
surrounding facts and circumstances. However, merely because a 
collective bargaining agreement provides that a plan may be modified at 
the termination of such agreement, or that particular provisions of the 
plan are subject to renegotiation during the duration of such agreement, 
does not necessarily imply that the plan is not a permanent arrangement. 
Moreover, the fact that the plan provides that the assets remaining in 
the trust after the satisfaction of all liabilities (including 
contingent liabilities) under the plan may be returned to the employer 
does not imply that the plan is not a permanent arrangement nor preclude 
the trust from qualifying under section 501(c)(17).
    (e) Portions of years. A plan must satisfy the requirements of 
section 501(c)(17) throughout the entire taxable year of the trust in 
order for the trust to be exempt for such year. However, section 
501(c)(17)(C) provides that a plan will satisfy the nondiscrimination as 
to classification requirements of section 501(c)(17)(A) if on at least 
one day in each quarter of the taxable year of the trust it satisfies 
such requirements.
    (f) Several trusts constituting one plan. Several trusts may be 
designated as constituting part of one plan which is intended to satisfy 
the requirements of

[[Page 40]]

section 501(c)(17), in which case all of such trusts taken as a whole 
must meet the requirements of such section. The fact that a combination 
of trusts fails to satisfy the requirements of section 501(c)(17) as one 
plan does not prevent such of the trusts as satisfy the requirements of 
section 501(c)(17) from qualifying for exemption under that section.
    (g) Plan of several employers. A trust forming part of a plan of 
several employers, or the employees of several employers, will be a 
supplemental unemployment benefit trust described in section 501(c)(17) 
if all the requirements of that section are otherwise satisfied.
    (h) Investment of trust funds. No specific limitations are provided 
in section 501(c)(17) with respect to investments which may be made by 
the trustees of a trust qualifying under that section. Generally, the 
contributions may be used by the trustees to purchase any investments 
permitted by the trust agreement to the extent allowed by local law. 
However, the tax-exempt status of the trust will be forfeited if the 
investments made by the trustees constitute prohibited transactions 
within the meaning of section 503. See section 503 and the regulations 
thereunder. In addition, such a trust will be subject to tax under 
section 511 with respect to any unrelated business taxable income (as 
defined in section 512) realized by it from its investments. See 
sections 511 to 515, inclusive, and the regulations thereunder.
    (i) Allocations. If a plan which provides sick and accident benefits 
is financed solely by employer contributions to the trust, and such sick 
and accident benefits are funded by payment of premiums on an accident 
or health insurance policy (whether on a group or individual basis) or 
by contributions to a separate fund which pays such sick and accident 
benefits, the plan must specify that portion of the contributions to be 
used to fund such benefits. If a plan which is financed in whole or in 
part by employee contributions provides sick and accident benefits, the 
plan must specify the portion, if any, of employee contributions 
allocated to the cost of funding such benefits, and must allocate the 
cost of funding such benefits between employer contributions and 
employee contributions.
    (j) Required records and returns. Every trust described in section 
501(c)(17) must maintain records indicating the amount of separation 
benefits and sick and accident benefits which have been provided to each 
employee. If a plan is financed, in whole or in part, by employee 
contributions to the trust, the trust must maintain records indicating 
the amount of each employee's total contributions allocable to 
separation benefits. In addition, every trust described in section 
501(c)(17) which makes one or more payments totaling $600 or more in 1 
year to an individual must file an annual information return in the 
manner described in paragraph (b)(1) of Sec. 1.6041-2. However, if the 
payments from such trust are subject to income tax withholding under 
section 3402(o) and the regulations thereunder, the trust must file, in 
lieu of such annual information return, the returns of income tax 
withheld from wages required by section 6011 and the regulations 
thereunder. In such circumstances, the trust must also furnish the 
statements to the recipients of trust distributions required by section 
6051 and the regulations thereunder.

[T.D. 6972, 33 FR 12901, Sept. 12, 1968, as amended by T.D. 7068, 35 FR 
17328, Nov. 11, 1970]



Sec. 1.501(c)(17)-3  Relation to other sections of the Code.

    (a) Taxability of benefit distributions--(1) Separation benefits. If 
the separation benefits described in section 501(c)(17)(D)(i) are funded 
entirely by employer contributions, then the full amount of any 
separation benefit payment received by an employee is includible in his 
gross income under section 61(a). If any such separation benefit is 
funded by both employer and employee contributions, or solely by 
employee contributions, the amount of any separation benefit payment 
which is includible in the gross income of the employee is the amount by 
which such distribution and any prior distributions of such separation 
payments exceeds the employee's total contributions to fund such 
separation benefits.

[[Page 41]]

    (2) Sick and accident benefits. Any benefit payment received from 
the trust under the part of the plan, if any, which provides for the 
payment of sick and accident benefits must be included in gross income 
under section 61(a), unless specifically excluded under section 104 or 
105 and the regulations thereunder. See section 105(b) and Sec. 1.105-2 
for benefit payments expended for medical care, benefit payments in 
excess of actual medical expenses, and benefit payments which an 
employee is entitled to receive irrespective of whether or not he incurs 
expenses for medical care. See section 213 and Sec. 1.213-1(g) for 
benefit payments representing reimbursement for medical expenses paid in 
prior years. See Sec. 1.501(c)(17)-2(i) for the requirement that a 
trust described in section 501(c)(17) which receives employee 
contributions must be part of a written plan which provides for the 
allocation of the cost of funding sick and accident benefits.
    (b) Exemption as a voluntary employees' beneficiary association. 
Section 501(c)(17)(E) contemplates that a trust forming part of a plan 
providing for the payment of supplemental unemployment compensation 
benefits may, if it qualifies, apply for exemption from income tax under 
section 501(a) either as a voluntary employees' beneficiary association 
described in section 501(c)(9) or as a trust described in section 
501(c)(17).
    (c) Returns. A trust which is described in section 501(c)(17) and 
which is exempt from tax under section 501(a) must file a return in 
accordance with section 6033 and the regulations thereunder. If such a 
trust realizes any unrelated business taxable income, as defined in 
section 512, the trust is also required to file a return with respect to 
such income.
    (d) Effective date. Section 501(c)(17) shall apply to taxable years 
beginning after December 31, 1959, and shall apply to supplemental 
unemployment benefit trusts regardless of when created or organized.

[T.D. 6972, 33 FR 12902, Sept. 12, 1968]



Sec. 1.501(c)(18)-1  Certain funded pension trusts.

    (a) In general. Organizations described in section 501(c)(18) are 
trusts created before June 25, 1959, forming part of a plan for the 
payment of benefits under a pension plan funded only by contributions of 
employees. In order to be exempt, such trusts must also meet the 
requirements set forth in section 501(c)(18) (A), (B), and (C), and in 
paragraph (b) of this section.
    (b) Requirements for qualification. A trust described in section 
501(c)(18) must meet the following requirements:
    (1) Local law. The trust must be a valid, existing trust under local 
law, and must be evidenced by an executed written document.
    (2) Funding. The trust must be funded solely from contributions of 
employees who are members of the plan. For purposes of this section, the 
term contributions of employees shall include earnings on, and gains 
derived from, the assets of the trust which were contributed by 
employees.
    (3) Creation before June 25, 1959--(i) In general. The trust must 
have been created before June 25, 1959. A trust created before June 25, 
1959 is described in section 501(c)(18) and this section even though 
changes in the makeup of the trust have occurred since that time so long 
as these are not fundamental changes in the character of the trust or in 
the character of the beneficiaries of the trust. Increases in the 
beneficiaries of the trust by the addition of employees in the same or 
related industries, whether such additions are of individuals or of 
units (such as local units of a union) will generally not be considered 
a fundamental change in the character of the trust. A merger of a trust 
created after June 25, 1959 into a trust created before such date is not 
in itself a fundamental change in the character of the latter trust if 
the two trusts are for the benefit of employees of the same or related 
industries.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. Assume that trust C, for the benefit of members of 
participating locals of National Union X, was established in 1950 and 
adopted by 29 locals before June 25, 1959. The subsequent adoption of 
trust C by additional locals of National Union X in 1962 will not 
constitute a fundamental change in the character of trust C, since such 
subsequent adoption is by employees in a related industry.

[[Page 42]]

    Example 2. Assume the facts as stated in example 1, except that in 
1965 National Union X merged with National Union Y, whose members are 
engaged in trades related to those engaged in by X's members. Assume 
further that trust D, the employee funded pension plan and fund for 
employees of Y, was subsequently merged into trust C. The merger of 
trust D into trust C would not in itself constitute a fundamental change 
in the character of trust C, since both C and D are for the benefit of 
employees of related industries.

    (4) Payment of benefits. The trust must provide solely for the 
payment of pension or retirement benefits to its beneficiaries. For 
purposes of this section, the term retirement benefits is intended to 
include customary and incidental benefits, such as death benefits within 
the limits permissible under section 401.
    (5) Diversion. The trust must be part of a plan which provides that, 
before the satisfaction of all liabilities to employees covered by the 
plan, the corpus and income of the trust cannot (within the taxable year 
and at any time thereafter) be used for, or diverted to, any purpose 
other than the providing of pension or retirement benefits. Payment of 
expenses in connection with the administration of a plan providing 
pension or retirement benefits shall be considered a payment to provide 
such benefits and shall not affect the qualification of the trust.
    (6) Discrimination. The trust must be part of a plan whose 
eligibility conditions and benefits do not discriminate in favor of 
employees who are officers, shareholders, persons whose principal duties 
consist of supervising the work of other employees, or highly 
compensated employees. See sections 401(a)(3)(B) and 401(a)(4) and 
Sec. Sec. 1.401-3 and 1.401-4. However, a plan is not discriminatory 
within the meaning of section 501(c)(18) merely because the benefits 
received under the plan bear a uniform relationship to the total 
compensation, or the basic or regular rate of compensation, of the 
employees covered by the plan. Accordingly, the benefits provided for 
highly paid employees may be greater than the benefits provided for 
lower paid employees if the benefits are determined by reference to 
their compensation; but, in such a case, the plan will not qualify if 
the benefits paid to the higher paid employees are a larger portion of 
compensation than the benefits paid to lower paid employees.
    (7) Objective standards. The trust must be part of a plan which 
requires that benefits be determined according to objective standards. 
Thus, while a plan may provide similarly situated employees with 
benefits which differ in kind and amount, these benefits may not be 
determined solely in the discretion of the trustees.
    (c) Effective date. The provisions of section 501(c)(18) and this 
section shall apply with respect to taxable years beginning after 
December 31, 1969.

[T.D. 7172, 37 FR 5618, Mar. 17, 1972]



Sec. 1.501(c)(19)-1  War veterans organizations.

    (a) In general. (1) For taxable years beginning after December 31, 
1969, a veterans post or organization which is organized in the United 
States or any of its possessions may be exempt as an organization 
described in section 501(c)(19) if the requirements of paragraphs (b) 
and (c) of this section are met and if no part of its net earnings 
inures to the benefit of any private shareholder or individual. 
Paragraph (b) of this section contains the membership requirements such 
a post or organization must meet in order to qualify under section 
501(c)(19). Paragraph (c) of this section outlines the purposes, at 
least one of which such a post or organization must have in order to so 
qualify.
    (2) In addition, an auxiliary unit or society described in paragraph 
(d) of this section of such a veterans post or organization and a trust 
or foundation described in paragraph (e) of this section for such post 
or organization may be exempt as an organization described in section 
501(c)(19).
    (b) Membership requirements. (1) In order to be described in section 
501(c)(19) under paragraph (a)(1) of this section, an organization must 
meet the membership requirements of section 501(c)(19)(B) and this 
paragraph. There are two requirements that must be met under this 
paragraph. The first requirement is that at least 75 percent of the 
members of the organization must be

[[Page 43]]

war veterans. For purposes of this section the term war veterans means 
persons, whether or not present members of the United States Armed 
Forces, who have served in the Armed Forces of the United States during 
a period of war (including the Korean and Vietnam conflicts).
    (2) The second requirement of this paragraph is that at least 97.5 
percent of all members of the organization must be described in one or 
more of the following categories:
    (i) War veterans,
    (ii) Present or former members of the United States Armed Forces,
    (iii) Cadets (including only students in college or university ROTC 
programs or at Armed Services academies), or
    (iv) Spouses, widows, or widowers of individuals referred to in 
paragraph (b)(2) (i), (ii) or (iii) of this section.
    (c) Exempt purposes. In addition to the requirements of paragraphs 
(a)(1) and (b) of this section, in order to be described in section 
501(c)(19) under paragraph (a)(1) of this section an organization must 
be operated exclusively for one or more of the following purposes:
    (1) To promote the social welfare of the community as defined in 
Sec. 1.501(c)(4)-1(a)(2).
    (2) To assist disabled and needy war veterans and members of the 
United States Armed Forces and their dependents, and the widows and 
orphans of deceased veterans,
    (3) To provide entertainment, care, and assistance to hospitalized 
veterans or members of the Armed Forces of the United States,
    (4) To carry on programs to perpetuate the memory of deceased 
veterans and members of the Armed Forces and to comfort their survivors,
    (5) To conduct programs for religious, charitable, scientific, 
literary, or educational purposes,
    (6) To sponsor or participate in activities of a patriotic nature,
    (7) To provide insurance benefits for their members or dependents of 
their members or both, or
    (8) To provide social and recreational activities for their members.
    (d) Auxiliary units or societies for war veterans organizations. A 
unit or society may be exempt as an organization described in section 
501(c)(19) and paragraph (a)(2) of this section if it is an auxiliary 
unit or society of a post or organization of war veterans described in 
paragraph (a)(1) of this section. A unit or society is an auxiliary unit 
or society or such a post or organization if it meets the following 
requirements:
    (1) It is affiliated with, and organized in accordance with, the 
bylaws and regulations formulated by an organization described in 
paragraph (a)(1) of this section,
    (2) At least 75 percent of its members are either war veterans, or 
spouses of war veterans, or are related to a war veteran within two 
degrees of consanguinity (i.e., grandparent, brother, sister, 
grandchild, represent the most distant allowable relationships),
    (3) All of its members are either members of an organization 
described in paragraph (a)(1) of this section, or spouses of a member of 
such an organization or are related to a member of such an organization, 
within two degrees of consanguinity, and
    (4) No part of its net earnings inures to the benefit of any private 
shareholder or individual.
    (e) Trusts or foundations. A trust or foundation may be exempt as an 
organization described in section 501(c)(19) and paragraph (a)(2) of 
this section if it is a trust or foundation for a post or organization 
of war veterans described in paragraph (a)(1) of this section. A trust 
or foundation is a trust or foundation for such a post or organization 
if it meets the following requirements:
    (1) The trust or foundation is in existence under local law and, if 
organized for charitable purposes, has a dissolution provision described 
in Sec. 1.501(c)(3)-1(b)(4).
    (2) The corpus or income cannot be diverted or used other than for 
the funding of a post or organization of war veterans described in 
paragraph (a)(1) of this section, for section 170(c)(4) purposes, or as 
an insurance set aside (as defined in Sec. 1.512(a)-4(b)).
    (3) The trust income is not unreasonably accumulated and, if the 
trust or foundation is not an insurance set aside, a substantial portion 
of the income is in fact distributed to such post or organization or for 
section 170(c)(4) charitable purposes, and

[[Page 44]]

    (4) It is organized exclusively for one or more of those purposes 
enumerated in paragraph (c) of this section.

[T.D. 7438, 41 FR 44392, Oct. 8, 1976]



Sec. 1.501(c)(21)-1  Black lung trusts--certain terms.

    (a) Created or organized in the United States. A trust is not 
created or organized in the United States unless it is maintained at all 
times as a domestic trust in the United States. For this purpose, 
section 7701(a)(9) limits the term United States to the District of 
Columbia and States of the United States.
    (b) Insurance company. The term insurance company means an 
insurance, surety, bonding or other company whose liability for the 
kinds of claims to which section 501(c)(21)(A)(i) applies is as an 
insurer or guarantor of the liabilities of another.
    (c) Black Lung Acts. The term Black Lung Acts includes any State law 
providing compensation for disability or death due to pneumoconiosis 
even though the State law compensates for other kinds of injuries. In 
such a case, section 501(c)(21) applies only to the extent that the 
liability is attributable to disability or death due to pneumoconiosis. 
For this purpose, the term pneumoconiosis has the same meaning as it has 
under federal law. See 30 U.S.C. 902.
    (d) Insurance exclusively covering such liability. The term 
insurance exclusively covering such liability includes insurance that 
covers risk for liabilities in addition to the liabilities to which 
section 501(c)(21)(A)(i) applies. In such a case, payment for premiums 
may be made from the trust only to the extent of that portion of the 
premiums that has been separately allocated and stated by the insurer as 
attributable solely to coverage of the liabilities to which section 
501(c)(21)(A)(i) applies.
    (e) Administrative and other incidental expenses. The term 
administrative and other incidental expenses means expenditures that are 
appropriate and helpful to the trust making them in carrying out the 
purposes for which its assets may be used under section 501(c)(21)(B). 
The term includes any exicse tax imposed on the trust under section 4952 
(relating to taxes on taxable expenditures) and reasonable expenses, 
such as legal expenses, incurred by the trust in connection with an 
assertion against the trust of liability for a taxable expenditure. The 
term does not include an excise tax imposed on the trustee or on other 
disqualified persons under section 4951 (relating to taxes on self-
dealing) or under section 4953 (relating to tax on excess contributions 
to black lung benefit trusts) or any expenses incurred in connection 
with the assertion of these taxes other than expenses that are treated 
as part of reasonable compensation under section 4951(d)(2)(C). See 
Sec. Sec. 53.4941 (d)-2(f)(3) and (d)-3(c) for interpretations of 
similar provisions under section 4941(d)(2)(E), relating to reasonable 
compensation for private foundation disqualified persons.
    (f) Public debt securities of the United States. The term public 
debt securities of the United States means obligations that are taken 
into consideration for purposes of the public debt limit. See, for 
example 31 U.S.C. 757b.
    (g) Obligations of a State or local government. The term obligations 
of a State or local government means the obligations of a State or local 
governmental unit the interest on which is exempt from tax under section 
103(a). See Sec. 1.103-1(a).
    (h) Time or demand deposits. The term time or demand deposits 
includes checking accounts, savings accounts, certificates of deposit or 
other time or demand deposits. The term does not include common or 
collective trust funds such as a common trust fund as defined in section 
584.

[44 FR 52197, Sept. 7, 1979]



Sec. 1.501(c)(21)-2  Same--trust instrument.

    As trust does not meet the requirements of section 501(c)(21) if it 
is not established and maintained pursuant to a written instrument. The 
trust instrument must definitely and affirmatively prohibit a diversion 
or use of trust assets that is not permitted under section 501(c)(21)(B) 
or section 4953(c), whether by operation or natural termination of the 
trust, by power of revocation or amendment by the happening of a 
contingency by collateral arrangement, or by any other means. No 
particular form for the trust

[[Page 45]]

instrument is required. A trust may meet the requirements of section 
501(c)921) although the trust instrument fails to contain provisions the 
effects of which are to prohibit acts that are subject to section 4951 
(relating to taxes on self-dealing), section 4952 (relating to taxes on 
taxable expenditures) or the retention of contributions subject to 
section 4953 (relating to tax on excess contributions to black lung 
benefit trusts).

[44 FR 52197, Sept. 7, 1979]



Sec. 1.501(d)-1  Religious and apostolic associations or corporations.

    (a) Religious or apostolic associations or corporations are 
described in section 501(d) and are exempt from taxation under section 
501(a) if they have a common treasury or community treasury, even though 
they engage in business for the common benefit of the members, provided 
each of the members includes (at the time of filing his return) in his 
gross income his entire pro rata share, whether distributed or not, of 
the net income of the association or corporation for the taxable year of 
the association or corporation ending with or during his taxable year. 
Any amount so included in the gross income of a member shall be treated 
as a dividend received.
    (b) For annual return requirements of organizations described in 
section 501(d), see section 6033 and paragraph (a)(5) of Sec. 1.6033-1.



Sec. 1.501(e)-1  Cooperative hospital service organizations.

    (a) General rule. Section 501(e) is the exclusive and controlling 
section under which a cooperative hospital service organization can 
qualify as a charitable organization. A cooperative hospital service 
organization which meets the requirements of section 501(e) and this 
section shall be treated as an organization described in section 
501(c)(3), exempt from taxation under section 501(a), and referred to in 
section 170(b)(1)(A) (iii) (relating to percentage limitations on 
charitable contributions). In order to qualify for tax exempt status, a 
cooperative hospital service organization must--
    (1) Be organized and operated on a cooperative basis,
    (2) Perform, on a centralized basis, only one or more specifically 
enumerated services which, if performed directly by a tax exempt 
hospital, would constitute activities in the exercise or performance of 
the purpose or function constituting the basis for its exemption, and
    (3) Perform such service or services solely for two or more patron-
hospitals as described in paragraph (d) of this section.
    (b) Organized and operated on a cooperative basis--(1) In general. 
In order to meet the requirements of section 501(e), the organization 
must be organized and operated on a cooperative basis (whether or not 
under a specific statute on cooperatives) and must allocate or pay all 
of its net earnings within 8\1/2\ months after the close of the taxable 
year to its patron-hospitals on the basis of the percentage of its 
services performed for each patron. To allocate its net earnings to its 
patron-hospitals, the organization must make appropriate bookkeeping 
entries and provide timely written notice to each patron-hospital 
disclosing to the patron-hospital the amount allocated to it on the 
books of the organization. For the recordkeeping requirements of a 
section 501(e) organization, see Sec. 1.521-1(a)(1).
    (2) Percentage of services defined. The percentage of services 
performed for each patron-hospital may be determined on the basis of 
either the value or the quantity of the services provided by the 
organization to the patron-hospital, provided such basis is realistic in 
terms of the actual cost of the services to the organization.
    (3) Retention of net earnings. Exemption will not be denied a 
cooperative hospital service organization solely because the 
organization, instead of paying all net earnings to its patron-
hospitals, retains an amount for such purposes as retiring indebtedness, 
expanding the services of the organization, or for any other necessary 
purpose and allocates such amounts to its patrons. However, such funds 
may not be accumulated beyond the reasonably anticipated needs of the 
organization. See, Sec. 1.537-1(b). Whether there is an improper 
accumulation of funds depends upon the particular circumstances of

[[Page 46]]

each case. Moreover, where an organization retains net earnings for 
necessary purposes, the organization's records must show each patron's 
rights and interests in the funds retained. For purposes of this 
paragraph, the term net earnings does not include capital contributions 
to the organization and such contributions need not satisfy the 
allocation or payment requirements.
    (4) Nonpatronage and other income. An organization described in 
section 501(e) may, in addition to net earnings, receive membership dues 
and related membership assessment fees, gifts, grants and income from 
nonpatronage sources such as investment of retained earnings. However, 
such an organization cannot be exempt if it engages in any business 
other than that of providing the specified services, described in 
paragraph (c), for the specified patron-hospitals, described in 
paragraph (d). Thus, an organization described in section 501(e) 
generally cannot have unrelated business taxable income as defined in 
section 512, although it may earn certain interest, annuities, 
royalties, and rents which are excluded from unrelated business taxable 
income because of the modifications contained in sections 512(b) (1), 
(2) or (3). An organization described in section 501(e) may, however, 
have debt-financed income which is treated as unrelated business taxable 
income solely because of the applicability of section 514. In addition, 
exempt status under section 501(e) will not be affected where rent from 
personal property leased with real property is treated as unrelated 
business taxable income under section 512(b)(3)(A)(ii) solely because 
the rent attributable to the personal property is more than incidental 
or under section 512(b)(3)(B)(i) solely because the rent attributable to 
the personal property exceeds 50 percent of the total rent received or 
accrued under the lease. Exemption will not be affected solely because 
the determination of the amount of rent depends in whole or in part on 
the income or profits derived from the property leased. See, section 
512(b)(3)(B)(ii). An organization described in section 501(e) may also 
derive nonpatronage income from sources that are incidental to the 
conduct of its exempt purposes or functions. For example, income derived 
from the operation of a cafeteria or vending machines primarily for the 
convenience of its employees or the disposition of by-products in 
substantially the same state they were in on completion of the exempt 
function (e.g., the sale of silver waste produced in the processing of 
x-ray film) will not be considered unrelated business taxable income. 
See, section 513(a)(2) and Sec. 1.513-1(d)(4)(ii). The nonpatronage and 
other income permitted under this subparagraph (4) must be allocated or 
paid as provided in subparagraph (1) or retained as provided in 
subparagraph (3).
    (5) Stock ownership--(i) Capital stock of organization. An 
organization does not meet the requirements of section 501(e) unless all 
of the organization's outstanding capital stock, if there is such stock, 
is held solely by its patron-hospitals. However, no amount may be paid 
as dividends on the capital stock of the organization. For purposes of 
the preceding sentence, the term capital stock includes common stock 
(whether voting or nonvoting), preferred stock, or any other form 
evidencing a proprietary interest in the organization.
    (ii) Stock ownership as a condition for obtaining credit. If by 
statutory requirement a cooperative hospital service organization must 
be a shareholder in a United States or state chartered corporation as a 
condition for obtaining credit from that corporate-lender, the ownership 
of shares and the payment of dividends thereon will not for such reason 
be a basis for the denial of exemption to the organization. See, e.g., 
National Consumer Cooperative Bank, 12 U.S.C. 3001 et seq.
    (c) Scope of services--(1) Permissible services. An organization 
meets the requirements of section 501(e) only if the organization 
performs, on a centralized basis, one or more of the following services 
and only such services: data processing, purchasing (including the 
purchasing and dispensing of drugs and pharmaceuticals to patron-
hospitals), warehousing, billing and collection, food, clinical 
(including radiology), industrial engineering (including the 
installation, maintenance and repair of biomedical and similar 
equipment), laboratory, printing, communications, record center, and 
personnel (including

[[Page 47]]

recruitment, selection, testing, training, education and placement of 
personnel) services. An organization is not described in section 501(e) 
if, in addition to or instead of one or more of these specified 
services, the organization performs any other service (other than 
services referred to under paragraph (b)(4) that are incidental to the 
conduct of exempt purposes or functions).
    (2) Illustration. The provisions of this subparagraph may be 
illustrated by the following example.

    Example. An organization performs industrial engineering services on 
a cooperative basis solely for patron-hospitals each of which is an 
organization described in section 501(c)(3) and exempt from taxation 
under section 501(a). However, in addition to this service, the 
organization operates laundry services for its patron-hospitals. This 
cooperative organization does not meet the requirements of this 
paragraph because it performs laundry services not specified in this 
paragraph.

    (d) Patron-hospitals--(1) Defined. Section 501(e) only applies if 
the organization performs its services solely for two or more patron-
hospitals each of which is--
    (i) An organization described in section 501(c)(3) which is exempt 
from taxation under section 501(a),
    (ii) A constituent part of an organization described in section 
501(c)(3) which is exempt from taxation under section 501(a) and which, 
if organized and operated as a separate entity, would constitute an 
organization described in section 501(c)(3), or
    (iii) Owned and operated by the United States, a State, the District 
of Columbia, or a possession of the United States, or a political 
subdivision or an agency or instrumentality of any of the foregoing.
    (2) Business with nonvoting patron-hospitals. Exemption will not be 
denied a cooperative hospital service organization solely because the 
organization (whether organized on a stock or membership basis) 
transacts business with patron-hospitals which do not have voting rights 
in the organization and therefore do not participate in the decisions 
affecting the operation of the organization. Where the organization has 
both patron-hospitals with voting rights and patron-hospitals without 
such rights, the organization must provide at least 50 percent of its 
services to patron-hospitals with voting rights in the organization. 
Thus, the percentage of services provided to nonvoting patrons may not 
exceed the percentage of such services provided to voting patrons. A 
patron-hospital will be deemed to have voting rights in the cooperative 
hospital service organization if the patron-hospital may vote directly 
on matters affecting the operation of the organization or if the patron-
hospital may vote in the election of cooperative board members. 
Notwithstanding that an organization may have both voting and nonvoting 
patron-hospitals, patronage refunds must nevertheless be allocated or 
paid to all patron-hospitals solely on the basis specified in paragraph 
(b) of this section.
    (3) Services to other organizations. An organization does not meet 
the requirements of section 501(e) if, in addition to performing 
services for patron-hospitals (entities described in subdivisions (i), 
(ii) or (iii) of subparagraph (1)), the organization performs any 
service for any other organization. For example, a cooperative hospital 
service organization is not exempt if it performs services for 
convalescent homes for children or the aged, vocational training 
facilities for the handicapped, educational institutions which do not 
provide hospital care in their facilities, and proprietary hospitals. 
However, the provision of the specified services between or among 
cooperative hospital service organizations meeting the requirements of 
section 501(e) and this section is permissible. Also permissible is the 
provision of the specified services to entities which are not patron-
hospitals, but only if such services are de minimis and are mandated by 
a governmental unit as, for example, a condition for licensing.
    (e) Effective dates. An organization, other than an organization 
performing clinical services, may meet the requirements of section 
501(e) and be a tax exempt organization for taxable years ending after 
June 28, 1968. An organization performing clinical services may meet the 
requirements of section 501(e) and be a tax exempt organization for 
taxable years ending after December 31, 1976. However, pursuant to the

[[Page 48]]

authority contained in section 7805(b) of the Internal Revenue Code, 
these regulations shall not become effective with respect to an 
organization which has received a ruling or determination letter from 
the Internal Revenue Service recognizing its exemption under section 
501(e) until January 2, 1987.

[T.D. 8100, 51 FR 31615, Sept. 4, 1986; 51 FR 33593, Sept. 22, 1986]



Sec. 1.501(h)-1  Application of the expenditure test to expenditures to 

influence legislation; introduction.

    (a) Scope. (1) There are certain requirements an organization must 
meet in order to be a charity described in section 501(c)(3). Among 
other things, section 501(c)(3) states that ``no substantial part of the 
activities of [a charity may consist of] carrying on propaganda, or 
otherwise attempting to influence legislation, (except as otherwise 
provided in subsection (h)).'' This requirement is called the 
substantial part test.
    (2) Under section 501(h), many public charities may elect the 
expenditure test as a substitute for the substantial part test. The 
expenditure test is described in section 501(h) and this Sec. 1.501(h). 
A public charity is any charity that is not a private foundation under 
section 509(a). (Unlike a public charity, a private foundation may not 
make any lobbying expenditures: If a private foundation does make a 
lobbying expenditure, it is subject to an excise tax under section 
4945). Section 1.501(h)-2 lists which public charities are eligible to 
make the expenditure test election. Section 1.501(h)-2 also provides 
information about how a public charity makes and revokes the election to 
be covered by the expenditure test.
    (3) A public charity that makes the election may make lobbying 
expenditures within specified dollar limits. If an electing public 
charity's lobbying expenditures are within the dollar limits determined 
under section 4911(c), the electing public charity will not owe tax 
under section 4911 nor will it lose its tax exempt status as a charity 
by virtue of section 501(h). If, however, that electing public charity's 
lobbying expenditures exceed its section 4911 lobbying limit, the 
organization is subject to an excise tax on the excess lobbying 
expenditures. Further, under section 501(h), if an electing public 
charity's lobbying expenditures normally are more than 150 percent of 
its section 4911 lobbying limit, the organization will cease to be a 
charity described in section 501(c)(3).
    (4) A public charity that elects the expenditure test may 
nevertheless lose its tax exempt status if it is an action organization 
under Sec. 1.501(c)(3)-1(c)(3)(iii) or (iv). A public charity that does 
not elect the expenditure test remains subject to the substantial part 
test. The substantial part test is applied without regard to the 
provisions of section 501(h) and 4911 and the related regulations.
    (b) Effective date. The provisions of Sec. 1.501(h)-1 through Sec. 
1.501(h)-3, are effective for taxable years beginning after August 31, 
1990. An election made before August 31, 1990, under the provisions of 
Sec. 7.0(c)(4) or the instructions to Form 5768, will be effective 
under these regulations without again filing Form 5768.

[T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec. 1.501(h)-2  Electing the expenditure test.

    (a) In general. The election to be governed by section 501(h) may be 
made by an eligible organization (as described in paragraph (b) of this 
section) for any taxable year of the organization beginning after 
December 31, 1976, other than the first taxable year for which a 
voluntary revocation of the election is effective (see paragraph (d) of 
this section). The election is made by filing a completed Form 5768, 
Election/Revocation of Election by an Eligible Section 501(c)(3) 
Organization to Make Expenditures to Influence Legislation, with the 
appropriate Internal Revenue Service Center listed on that form. Under 
section 501(h)(6), the election is effective with the beginning of the 
taxable year in which the form is filed. For example, if an eligible 
organization whose taxable year is the calendar year files Form 5768 on 
December 31, 1979, the organization is governed by section 501(h) for 
its taxable year beginning January 1, 1979. Once made, the expenditure 
test election is effective (without again filing Form 5768) for each 
succeeding taxable year for which

[[Page 49]]

the organization is an eligible organization and which begins before a 
notice of revocation is filed under paragraph (d) of this section.
    (b) Organizations eligible to elect the expenditure test--(1) In 
general. For purposes of section 501(h) and the regulations thereunder, 
an organization is an eligible organization for a taxable year if, for 
that taxable year, it is--
    (i) Described in section 501(c)(3) (determined, in any year for 
which an election is in effect, without regard to the substantial part 
test of section 501(c)(3)),
    (ii) Described in section 501(h)(4) and paragraph (b)(2) of this 
section, and
    (iii) Not a disqualified organization described in section 501(h)(5) 
and paragraph (b)(3) of this section.
    (2) Certain organizations listed. An organization is described in 
section 501(h)(4) and this paragraph (b)(2) if it is an organization 
described in--
    (i) Section 170(b)(1)(A)(ii) (relating to educational institutions),
    (ii) Section 170(b)(1)(A)(iii) (relating to hospitals and medical 
research organizations),
    (iii) Section 170(b)(1)(A)(iv) (relating to organizations supporting 
government schools),
    (iv) Section 170(b)(1)(A)(vi) (relating to organizations publicly 
supported by charitable contributions),
    (v) Section 509(a)(2) (relating to organizations publicly supported 
by admissions, sales, etc.), or
    (vi) Section 509(a)(3) (relating to organizations supporting public 
charities), except that for purposes of this paragraph (b)(2), section 
509(a)(3) shall be applied without regard to the last sentence of 
section 509(a).
    (3) Disqualified organizations. An organization is a disqualified 
organization described in section 501(h)(5) and this paragraph (b)(3) if 
the organization is--
    (i) Described in section 170(b)(1)(A)(i) (relating to churches),
    (ii) An integrated auxiliary of a church or of a convention or 
association of churches see (Sec. 1.6033-2(g)(5)), or
    (iii) Described in section 501(c)(3) and affiliated (within the 
meaning of Sec. 56.4911-7) with one or more organizations described in 
paragraph (b)(3) (i) or (ii) of this section.
    (4) Other organizations ineligible to elect. Under section 
501(h)(4), certain organizations, although not disqualified 
organizations, are not eligible to elect the expenditure test. For 
example, organizations described in section 509(a)(4) are not listed in 
section 501(h)(4) and therefore are not eligible to elect. Similarly, 
private foundations (within the meaning of section 509(a)) are not 
eligible to elect. For the treatment of expenditures by a private 
foundation for the purpose of carrying on propaganda, or otherwise 
attempting, to influence legislation, see Sec. 53.4945-2.
    (c) New organizations. A newly created organization may submit Form 
5768 to elect the expenditure test under section 501(h) before it is 
determined to be an eligible organization and may submit Form 5768 at 
the time it submits its application for recognition of exemption (Form 
1023). If the newly created organization is determined to be an eligible 
organization, the election will be effective under the provisions of 
paragraph (a) of this section, that is, with the beginning of the 
taxable year in which the Form 5768 is filed by the eligible 
organization. However, if a newly created organization is determined by 
the Service not to be an eligible organization, the organization's 
election will not be effective and the substantial part test will apply 
from the effective date of its section 501(c)(3) classification.
    (d) Voluntary revocation of expenditure test election--(1) 
Revocation effective. An organization may voluntarily revoke an 
expenditure test election by filing a notice of voluntary revocation 
with the appropriate Internal Revenue Service Center listed on Form 
5768. Under section 501(h)(6)(B), a voluntary revocation is effective 
with the beginning of the first taxable year after the taxable year in 
which the notice is filed. If an organization voluntarily revokes its 
election, the substantial part test of section 501(c)(3) will apply with 
respect to the organization's activities in attempting to influence 
legislation beginning with the taxable year for which the voluntary 
revocation is effective.

[[Page 50]]

    (2) Re-election of expenditure test. If an organization's 
expenditure test election is voluntarily revoked, the organization may 
again make the expenditure test election, effective no earlier than for 
the taxable year following the first taxable year for which the 
revocation is effective.
    (3) Example. X, an organization whose taxable year is the calendar 
year, plans to voluntarily revoke its expenditure test election 
effective beginning with its taxable year 1985. X must file its notice 
of voluntary revocation on Form 5768 after December 31, 1983, and before 
January 1, 1985. If X files a notice of voluntary revocation on December 
31, 1984, the revocation is effective beginning with its taxable year 
1985. The organization may again elect the expenditure test by filing 
Form 5768. Under paragraph (d)(2) of this section, the election may not 
be made for taxable year 1985. Under paragraph (a) of this section, a 
new expenditure test election will be effective for taxable years 
beginning with taxable year 1986, if the Form 5768 is filed after 
December 31, 1985, and before January 1, 1987.
    (e) Involuntary revocation of expenditure test election. If, while 
an election by an eligible organization is in effect, the organization 
ceases to be an eligible organization, its election is automatically 
revoked. The revocation is effective with the beginning of the first 
full taxable year for which it is determined that the organization is 
not an eligible organization. If an organization's expenditure test 
election is involuntarily revoked under this paragraph (e) but the 
organization continues to be described in section 501(c)(3), the 
substantial part test of section 501(c)(3) will apply with respect to 
the organization's activities in attempting to influence legislation 
beginning with the first taxable year for which the involuntary 
revocation is effective.
    (f) Supersession. This section supersedes Sec. 7.0(c)(4) of the 
Temporary Income Tax Regulations under the Tax Reform Act of 1976, 
effective August 31, 1990.

[T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec. 1.501(h)-3  Lobbying or grass roots expenditures normally in excess of 

ceiling amount.

    (a) Scope. This section provides rules under section 501(h) for 
determining whether an organization that has elected the expenditure 
test and that is not a member of an affiliated group of organizations 
(as defined in Sec. 56.4911-7(e)) either normally makes lobbying 
expenditures in excess of its lobbying ceiling amount or normally makes 
grass roots expenditures in excess of its grass roots ceiling amount. 
Under section 501(h) and this section, an organization that has elected 
the expenditure test and that normally makes expenditures in excess of 
the corresponding ceiling amount will cease to be exempt from tax under 
section 501(a) as an organization described in section 501(c)(3). For 
similar rules relating to members of an affiliated group of 
organizations, see Sec. 56.4911-9.
    (b) Loss of exemption--(1) In general. Under section 501(h)(1), an 
organization that has elected the expenditure test shall be denied 
exemption from taxation under section 501(a) as an organization 
described in section 501(c)(3) for the taxable year following a 
determination year if--
    (i) The sum of the organization's lobbying expenditures for the base 
years exceeds 150 percent of the sum of its lobbying nontaxable amounts 
for the base years, or (ii) The sum of the organization's grass roots 
expenditures for its base years exceeds 150 percent of the sum of its 
grass roots nontaxable amounts for the base years.

The organization thereafter shall not be exempt from tax under section 
501(a) as an organization described in section 501(c)(3) unless, 
pursuant to paragraph (d) of this section, the organization reapplies 
for recognition of exemption and is recognized as exempt.
    (2) Special exception for organization's first election. For the 
first, second, or third consecutive determination year for which an 
organization's first expenditure test election is in effect, no 
determination is required under paragraph (b)(1) of this section, and 
the organization will not be denied exemption from tax by reason of 
section 501(h) and this section if, taking into account as base years 
only those years

[[Page 51]]

for which the expenditure test election is in effect--
    (i) The sum of the organization's lobbying expenditures for such 
base years does not exceed 150 percent of the sum of its lobbying 
nontaxable amounts for the same base years, and
    (ii) The sum of the organization's grass roots expenditure for those 
base years does not exceed 150 percent of the sum of its grass roots 
nontaxable amounts for such base years. If an organization does not 
satisfy the requirements of this paragraph (b)(2), paragraph (b)(1) of 
this section will apply.
    (c) Definitions. For purposes of this section--
    (1) The term lobbying expenditures means lobbying expenditures as 
defined in section 4911(c)(1) or section 4911(f)(4)(A) and Sec. 
56.4911-2(a).
    (2) The term lobbying nontaxable amount is defined in Sec. 56.4911-
1(c)(1).
    (3) An organization's lobbying ceiling amount is 150 percent of the 
organization's lobbying nontaxable amount for a taxable year.
    (4) The term grass roots expenditures means expenditures for grass 
roots lobbying communications as defined in section 4911(c)(3) or 
section 4911(f)(4)(A) and Sec. Sec. 56.4911-2 and 56.4911-3.
    (5) The term grass roots nontaxable amount is defined in Sec. 
56.4911-1(c)(2).
    (6) An organization's grass roots ceiling amount is 150 percent of 
the organization's grass roots nontaxable amount for a taxable year.
    (7) In general, the term base years means the determination year and 
the three taxable years immediately preceding the determination year. 
The base years, however, do not include any taxable year preceding the 
taxable year for which the organization is first treated as described in 
section 501(c)(3).
    (8) A taxable year is a determination year if it is a year for which 
the expenditure test election is in effect, other than the taxable year 
for which the organization is first treated as described in section 
501(c)(3).
    (d) Reapplication for recognition of exemption--(1) Time of 
application. An organization that is denied exemption from taxation 
under section 501(a) by reason of section 501(h) and this section may 
apply on Form 1023 for recognition of exemption as an organization 
described in section 501(c)(3) for any taxable year following the first 
taxable year for which exemption is so denied. See paragraphs (d)(2) and 
(d)(3) of this section for material to be included with an application 
described in the preceding sentence.
    (2) Section 501(h) calculation. An application described in 
paragraph (d)(1) of this section must demonstrate that the organization 
would not be denied exemption from taxation under section 501(a) by 
reason of section 501(h) if the expenditure test election has been in 
effect for all of its last taxable year ending before the application is 
made by providing the calculations, described either in paragraphs 
(b)(1) (i) and (ii) of this section or in Sec. 56.4911-9(b), that would 
have applied to the organization for that year.
    (3) Operations not disqualifying. An application described in 
paragraph (d)(1) of this section must include information that 
demonstrates to the satisfaction of the Commissioner that the 
organization will not knowingly operate in a manner that would 
disqualify the organization for tax exemption under section 501(c)(3) by 
reason of attempting to influence legislation.
    (4) Reelection of expenditure test. If an organization is denied 
exemption from tax for a taxable year by reason of section 501(h) and 
this section, and thereafter is again recognized as an organization 
described in section 501(c)(3) pursuant to this paragraph (d), it may 
again elect the expenditure test under section 501(h) in accordance with 
Sec. 1.501(h)-2(a).
    (e) Examples. The provisions of this section are illustrated by the 
following examples, which also illustrate the operation of the tax 
imposed by section 4911.

    Example 1. (1) The following table contains information used in this 
example concerning organization X.

[[Page 52]]



----------------------------------------------------------------------------------------------------------------
                                                                                             Lobbying
                                Exempt purpose                                   -------------------------------
             Year                expenditures              Calculation                               Lobbying
                                     (EPE)                                          Nontaxable     expenditures
                                                                                   amount (LNTA)       (LE)
----------------------------------------------------------------------------------------------------------------
1979..........................        $400,000  (20% of $400,000=)..............         $80,000        $100,000
1980..........................         300,000  (20% of $300,000=)..............          60,000         100,000
1981..........................         600,000  (20% of $500,000+15% of                  115,000         120,000
                                                 $100,000=).
1982..........................         500,000  (20% of $500,000=)..............         100,000         100,000
-----------------------------------------------                                  -------------------------------
  Totals......................       1,800,000  ................................         355,000         420,000
----------------------------------------------------------------------------------------------------------------

    (2) Organization X, whose taxable year is the calendar year, was 
organized in 1971. X first made the expenditure test election under 
section 501(h) effective for taxable years beginning with 1979 and has 
not revoked the election. None of X's lobbying expenditures for its 
taxable years 1979 through 1982 are grass roots expenditures. Under 
section 4911(a) and Sec. 56.4911-1(a), X must determine for each year 
for which the expenditure test election is effective whether it is 
liable for the 25 percent excise tax imposed by section 4911(a) on 
excess lobbying expenditures. X is liable for this tax for each of its 
taxable years 1979, 1980, and 1981, because in each year its lobbying 
expenditures exceeded its lobbying nontaxable amount for the year. For 
1979, the tax imposed by section 4911(a) is $5,000 {25%x($100,000-
$80,000)=$5,000{time} . For 1980, the tax is $10,000. For 1981, the tax 
is $1,250.
    (3) The taxable years 1979 through 1981 are all determination years 
under paragraph (c)(8) of this section. On its annual return for 
determination year 1979, the first year of its first election, X can 
demonstrate, under paragraph (b)(2) of this section, that its lobbying 
expenditures during 1979 ($100,000) do not exceed 150 percent of its 
lobbying nontaxable amount for 1979 ($120,000). For determination year 
1980, under paragraph (b)(2), X can demonstrate that the sum of its 
lobbying expenditures for 1979 and 1980 ($200,000) does not exceed 150 
percent of the sum of its lobbying nontaxable amounts for 1979 and 1980 
($210,000). For 1981, under paragraph (b)(2), X can demonstrate that the 
sum of its lobbying expenditures for 1979, 1980, and 1981 ($320,000) 
does not exceed 150 percent of the sum of its lobbying nontaxable 
amounts for 1979, 1980, and 1981 ($382,500). For each of the 
determination years 1979, 1980, and 1981, the first three years of its 
first election, X satisfies the requirements of paragraph (b)(2). 
Accordingly, no determination under paragraph (b)(1) of this section is 
required for those years, and X is not denied tax exemption by reason of 
section 501(h).
    (4) Under paragraph (b)(1) of this section, X must determine for its 
determination year 1982 whether it has normally made lobbying 
expenditures in excess of the lobbying ceiling amount. This 
determination takes into account expenditures in base years 1979 through 
1982. The sum of X's lobbying expenditures for the base years ($420,000) 
does not exceed 150 percent of the sum of the lobbying nontaxable 
amounts for the base years (150%x$355,000=$532,500). Accordingly, X is 
not denied tax exemption by reason of section 501(h).
    Example 2. (1) The following table contains information used in this 
example concerning W.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                            Grass roots
                                      Exempt purpose                                         Lobbying                       nontaxable
                                       expenditures                                         nontaxable       Lobbying       amount (25      Grass roots
                Year                       (EPE)                  Calculation              amount (LNTA)   expenditures     percent of     expenditures
                                         (dollars)                                           (dollars)    (LE) (dollars)       LNTA)         (dollars)
                                                                                                                             (dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1979................................         700,000  (20% of $500,000+15% of $200,000=)         130,000         120,000          32,500          30,000
1980................................         800,000  (20% of $500,000+15% of $300,000=)         145,000         100,000          36,250          60,000
1981................................         800,000  (20% of $500,000+15% of $300,000=)         145,000         100,000          36,250          65,000
1982................................         900,000  (20% of $500,000+15% of $400,000=)         160,000         150,000          40,000          65,000
                                     ----------------                                    ---------------------------------------------------------------
  Total.............................       3,200,000  ..................................         580,000         470,000         145,000         220,000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 53]]

    (2) Organization W, whose taxable year is the calendar year, made 
the expenditure test election under section 501(h) effective for taxable 
years beginning with 1979 and has not revoked the election. W has been 
treated as an organization described in section 501(c)(3) for each of 
its taxable years beginning within its taxable year 1974.
    (3) Under section 4911(a) and Sec. 56.4911-1(a), W must determine 
for each year for which the expenditure test election is effective 
whether it is liable for the 25 percent excise tax imposed by section 
4911(a) on excess lobbying expenditures. In 1980, 1981, and 1982, W has 
excess lobbying expenditures because its grass roots expenditures in 
each of those years exceeded its grass roots nontaxable amount for the 
year. Therefore, W is liable for the excise tax under section 4911(a) 
for those years. The tax imposed by section 4911(a) for 1980 is 
$5,937.50 {25%x($60,000-$36,250)= $5,937.50{time} . For 1981, the tax is 
$7,187.50. For 1982, the tax is $6,250.
    (4) On its annual return for its determination years 1979, 1980, and 
1981, the first three years of its first election, W demonstrates that 
it satisfies the requirements of paragraph (b)(2) of this section. 
Accordingly, no determination under paragraph (b)(1) of this section is 
required for those years, and W is not denied tax exemption by reason of 
section 501(h).
    (5) On its annual return for its determination year 1982, W must 
determine under paragraph (b)(1) whether it has normally made lobbying 
expenditures or grass roots expenditures in excess of the corresponding 
ceiling amount. This determination takes into account expenditures in 
base years 1979 through 1982. The sum of W's lobbying expenditures for 
the base years ($470,000) does not exceed 150% of the sum of W's 
lobbying nontaxable amounts for those years (150%x$580,000=$870,000). 
However, the sum of W's grass roots expenditures for the base years 
($220,000) does exceed 150% of the sum of W's grass roots nontaxable 
amonts for those years (150%x$145,000=$217,500). Under section 501(h), W 
is denied tax exemption under section 501(a) as an organization 
described in section 501(c)(3) for its taxable year 1983. For its 
taxable year 1984 and any taxable year thereafter, W is exempt from tax 
as an organization described in section 501(c)(3) only if W applies for 
recognition of its exempt status under paragraph (d) of this section and 
is recognized as exempt from tax.
    Example 3. (1) The following table contains information used in this 
example concerning organization Y.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                            Grass roots
                                      Exempt purpose                                         Lobbying        Lobbying       nontaxable      Grass roots
            Taxable Year               expenditures               Calculation               nontaxable     expenditures     amount (25     expenditures
                                           (EPE)                                           amount (LNTA)   (LE)(dollars)    percent of       (dollars)
                                         (dollars)                                           (dollars)                    LNTA)(dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1977................................         700,000  (20% of $500,000+15% of $200,000=)         130,000         182,000          32,500          30,000
1978................................         800,000  (20% of $500,000+15% of $300,000=)         145,000         224,750          36,250          35,000
                                     ----------------                                    ---------------------------------------------------------------
  Subtotal..........................       1,500,000  ..................................         275,000         406,750          68,750          65,000
1979................................         900,000  (20% of $500,000+15% of $400,000=)         160,000         264,000          40,000          50,000
                                     ----------------                                    ---------------------------------------------------------------
  Totals:...........................       2,400,000  ..................................         435,000         670,750         108,750         115,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (2) Organization Y, whose taxable year is the calendar year, was 
first treated as an organization described in section 501(c)(3) on 
February 1, 1977. Y made the expenditure test election under section 
501(h) effective for taxable years beginning with 1977 and has not 
revoked the election.
    (3) For 1977, Y has excess lobbying expenditures of $52,000 because 
its lobbying expenditures ($182,000) exceed its lobbying nontaxable 
amount ($130,000) for the taxable year. Accordingly, Y is liable for the 
25 percent excise tax imposed by section 4911(a). The amount of the tax 
is $13,000 [25%x($182,000-$130,000)=$13,000].
    (4) For 1978, Y again has excess lobbying expenditures and is again 
liable for the 25 percent excise tax imposed by section 4911(a). The 
amount of the tax is $19,937.50 [25%x($224,750-$145,000)=$19,937.50].
    (5) For 1979, Y's lobbying expenditures ($264,000) exceed its 
lobbying nontaxable amount ($160,000) by $104,000, and its grass roots 
expenditures ($50,000) exceed its grass roots nontaxable amount 
($40,000) by $10,000. Under Sec. 56.4911-1(b), Y's excess lobbying 
expenditures are the greater of $104,000 or $10,000. The amount of the 
tax, therefore, is $26,000 [25%x$104,000=$26,000].
    (6) Under paragraph (c)(8) of this section, 1977 is not a 
determination year because it is

[[Page 54]]

the first year for which the organization is treated as described in 
section 501(c)(3). For 1977, Y need not determine whether it has 
normally made lobbying expenditures or grass roots expenditures in 
excess of the corresponding ceiling amount for purposes of determining 
whether it is denied exemption under section 501(h) for its taxable year 
1978.
    (7) For determination year 1978, Y must determine whether it has 
normally made lobbying or grass roots expenditures in excess of the 
corresponding ceiling amount, taking into account expenditures for the 
base years 1977 and 1978. For Y, the determination under paragraph 
(b)(2) of this section considers the same base years as the 
determination under paragraph (b)(1) of this section and is, therefore, 
redundant. Accordingly, Y proceeds to determine, under (b)(1), whether 
it is denied exemption. Y's grass roots expenditures for 1977 and 1978 
($65,000) did not exceed 150 percent of the sum of its grass roots 
nontaxable amounts for those years ($103,125). Y's lobbying expenditures 
for 1977 and 1978 ($406,750) did not exceed 150% of its lobbying 
nontaxable amount for those years (150%x$275,000=$412,500). Therefore, Y 
is not denied tax exemption under section 501(h) for its taxable year 
1979.
    (8) For determination year 1979, the sum of Y's grass roots 
expenditures in base years 1977, 1978, and 1979 does not exceed 150 
percent of its grass roots nontaxable amount (calculation omitted). 
However, the sum of Y's lobbying expenditures for the base years 
($670,750) does exceed 150% of the sum of the lobbying nontaxable 
amounts for those years (150%x$435,000=$652,500). Since Y was not 
described in section 501(c)(3) prior to 1977, only the years 1977, 1978, 
and 1979 may be considered in determining whether Y has normally made 
lobbying expenditures in excess of its lobbying ceiling. Therefore, Y 
determines that it has normally made lobbying expenditures in excess of 
its lobbying ceiling. Under section 501(h), Y is denied tax exemption 
under section 501(a) as an organization described in section 501(c)(3) 
for its taxable year 1980. For its taxable year 1981, and any taxable 
year thereafter, Y is exempt from tax as an organization described in 
section 501(c)(3) only if Y applies for recognition of its exempt status 
under paragraph (d) of this section and is recognized as exempt from 
tax.
    Example 4. Organization M made the expenditure test election under 
section 501(h) effective for taxable years beginning with 1977 and has 
not revoked the election. M has $500,000 of exempt purpose expenditures 
during each of the years 1981 through 1984. In addition, during each of 
those years, M spends $75,000 for direct lobbying and $25,000 for grass 
roots lobbying. Since the amount expended for M's lobbying (both total 
lobbying and grass roots lobbying) is within the respective nontaxable 
expenditure limitations, M is not liable for the 25 percent excise tax 
imposed under section 4911(a) upon excess lobbying expenditures, nor is 
M denied tax-exempt status by reason of section 501 (h).
    Example 5. Assume the same facts as in Example 4, except that, on 
behalf of M, numerous unpaid volunteers conduct substantial lobbying 
activities with no reimbursement. Since the substantial lobbying 
activities of the unpaid volunteers are not counted towards the 
expenditure limitations and the amount expended for M's lobbying is 
within the respective nontaxable expenditure limitations, M is not 
liable for the 25 percent excise tax under section 4911, nor is M denied 
tax-exempt status by reason of section 501(h).

[T.D. 8308, 55 FR 35589, Aug. 31, 1990]



Sec. 1.501(k)-1  Communist-controlled organizations.

    Under section 11(b) of the Internal Security Act of 1950 (50 U.S.C. 
790(b)), as amended, which is made applicable to the Code by section 
7852(b) of that Code, no organization is entitled to exemption under 
sections 501(a) or 521(a) for any taxable year if at any time during 
such year such organization is registered under section 7 of such Act or 
if there is in effect a final order of the Subversive Activities Control 
Board established by section 12 of such Act requiring such organization 
to register under section 7 of such Act, or determining that it is a 
Communist-infiltrated organization.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; redesignated by T.D. 8100, 51 FR 
31615, Sept. 4, 1986]



Sec. 1.502-1  Feeder organizations.

    (a) In the case of an organization operated for the primary purpose 
of carrying on a trade or business for profit, exemption is not allowed 
under section 501 on the ground that all the profits of such 
organization are payable to one or more organizations exempt from 
taxation under section 501. In determining the primary purpose of an 
organization, all the circumstances must be considered, including the 
size and extent of the trade or business and the size and extent of 
those activities of such organization which are specified in the 
applicable paragraph of section 501.
    (b) If a subsidiary organization of a tax-exempt organization would 
itself

[[Page 55]]

be exempt on the ground that its activities are an integral part of the 
exempt activities of the parent organization, its exemption will not be 
lost because, as a matter of accounting between the two organizations, 
the subsidiary derives a profit from its dealings with its parent 
organization, for example, a subsidiary organization which is operated 
for the sole purpose of furnishing electric power used by its parent 
organization, a tax-exempt educational organization, in carrying on its 
educational activities. However, the subsidiary organization is not 
exempt from tax if it is operated for the primary purpose of carrying on 
a trade or business which would be an unrelated trade or business (that 
is, unrelated to exempt activities) if regularly carried on by the 
parent organization. For example, if a subsidiary organization is 
operated primarily for the purpose of furnishing electric power to 
consumers other than its parent organization (and the parent's tax-
exempt subsidiary organizations), it is not exempt since such business 
would be an unrelated trade or business if regularly carried on by the 
parent organization. Similarly, if the organization is owned by several 
unrelated exempt organizations, and is operated for the purpose of 
furnishing electric power to each of them, it is not exempt since such 
business would be an unrelated trade or business if regularly carried on 
by any one of the tax-exempt organizations. For purposes of this 
paragraph, organizations are related only if they consist of:
    (1) A parent organization and one or more of its subsidiary 
organizations; or
    (2) Subsidiary organizations having a common parent organization


An exempt organization is not related to another exempt organization 
merely because they both engage in the same type of exempt activities.
    (c) In certain cases an organization which carries on a trade or 
business for profit but is not operated for the primary purpose of 
carrying on such trade or business is subject to the tax imposed under 
section 511 on its unrelated business taxable income.
    (d) Exception--(1) Taxable years beginning before January 1, 1970. 
For purposes of section 502 and this section, for taxable years 
beginning before January 1, 1970, the term trade or business does not 
include the rental by an organization of its real property (including 
personal property leased with the real property).
    (2) Taxable years beginning after December 31, 1969. For purposes of 
section 502 and this section, for taxable years beginning after December 
31, 1969, the term trade or business does not include:
    (i) The deriving of rents described in section 512(b)(3)(A),
    (ii) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation, or
    (iii) Any trade or business (such as a thrift shop) which consists 
of the selling of merchandise, substantially all of which has been 
received by the organization as gifts or contributions


For purposes of the exception described in subdivision (i) of this 
subparagraph, if the rents derived by an organization would not be 
excluded from unrelated business income pursuant to section 512(b)(3) 
and the regulations thereunder, the deriving of such rents shall be 
considered a trade or business.
    (3) Cross references and special rules. (i) For determination of 
when rents are excluded from the tax on unrelated business income see 
section 512(b)(3) and the regulations thereunder.
    (ii) The rules contained in Sec. 1.513-1(e)(1) shall apply in 
determining whether a trade or business is described in section 
502(b)(2) and subparagraph (2)(ii) of this paragraph.
    (iii) The rules contained in Sec. 1.513-1(e)(3) shall apply in 
determining whether a trade or business is described in section 
502(b)(3) and subparagraph (2)(iii) of this paragraph.

[T.D. 6500, 25 FR 11737, No. 26, 1960, as amended by T.D. 6662, 28 FR 
6973, July 29, 1963; T.D. 7033, 35 FR 19997, Dec. 31, 1970]



Sec. 1.503(a)-1  Denial of exemption to certain organizations engaged in 

prohibited transactions.

    (a)(1) Prior to January 1, 1970, section 503 applies to those 
organizations described in sections 501(c)(3), 501(c)(17), and section 
401(a) except:(i) A religious organization (other than a trust);
    (ii) An educational organization which normally maintains a regular

[[Page 56]]

faculty and curriculum and normally has a regularly enrolled body of 
pupils or students in attendance at the place where its educational 
activities are regularly carried on;
    (iii) An organization which normally receives a substantial part of 
its support (exclusive or income received in the exercise or performance 
by such organization of its charitable, educational, or other purpose or 
function constituting the basis for its exemption under section 501(a)) 
from the United States or any State or political subdivision thereof or 
from direct of indirect contributions from the general public,
    (iv) An organization which is operated, supervised, controlled or 
principally supported by a religious organization (other than a trust) 
which is itself not subject to the provisions of this section; and
    (v) An organization the principal purposes or functions of which are 
the providing of medical or hospital care or medical education or 
medical research or agricultural research.
    (2) Effective January 1, 1907, and prior to January 1, 1975, section 
503 shall apply only to organizations described in section 501(c) (17) 
or (18) or section 401(a).
    (3) Effective January 1, 1975, section 503 shall apply only to 
organization described in section 501(c) (17) or (18) or described in 
section 401(a) and referred to in section 4975(g) (2) or (3).
    (b) The prohibited transactions enumerated in section 503(b) are in 
addition to and not in limitation of the restrictions contained in 
section 501(c) (3), (17), or (18) or section 401(a). Even though an 
organization has not engaged in any of the prohibited transactions 
referred to in section 503(b), it still may not qualify for tax 
exemptions in view of the general provisions of section 501(c) (3), 
(17), or (18) or section 401(a). Thus, if a trustee or other fiduciary 
of the organization (whether or not he is also a creater or such 
organization) enters into a transaction with the organization, such 
transaction will be closely scrutinized in the light of the fiduciary 
principle requiring undivided loyalty to ascertain whether the 
organization is in fact being operated for the stated exempt purpose.
    (c) An organization--(1) Described in section 501(c)(3) which after 
July 1, 1950, but before January 1, 1970, has engaged in any prohibited 
transaction as defined in section 503(b), unless it is excepted by the 
provisions of paragraph (a)(1) of this section;
    (2) Described in section 401(a) and referred to in section 4975(g) 
(2) or (3) which after March 1, 1954, has engaged in any prohibited 
transaction as defined in section 503(b);
    (3) Described in section 401(a) and not referred to in section 
4975(g) (2) or (3) which after March 1, 1954, but before January 1, 
1975, has engaged in any prohibited transaction as defined in section 
503(b) or which after December 31, 1962, but before January 1, 1975, has 
engaged in any prohibited transaction as defined in section 503(g) prior 
to its repeal by section 2003(b)(5) of the Employee Retirement Income 
Security Act of 1974 (88 Stat. 978);
    (4) Described in section 501(c)(17) which after December 31, 1959, 
has engaged in any prohibited transaction as defined in section 503(b); 
or
    (5) Described in section 501(c)(18) which after December 31, 1969, 
has engaged in any prohibited transaction described in section 503(b)


Shall not be exempt from taxation under section 501(a) for any taxable 
year subsequent to the taxable year in which there is mailed to it a 
notice in writing by the Commissioner that it has engaged in such 
prohibited transactions. Such notification by the Commissioner shall be 
by registered or certified mail to the last known name and address of 
the organization. However, notwithstanding the requirement of 
notification by the Commissioner, the exemption shall be denied with 
respect to any taxable year if such organization during or prior to such 
taxable year commenced the prohibited transaction with the purpose of 
diverting income or corpus from its exempt purposes and such transaction 
involved a substantial party of the income or corpus of such 
organization. For the purpose of this section, the term taxable year 
means the established annual accounting period of the organization; or,

[[Page 57]]

if the organization has no such established annual accounting period, 
the taxable year of the organizations means a calendar year. See 26 CFR 
Sec. 1.503(j)-1 (rev. as of Apr. 1, 1974) for provisions relating to 
the definition of prohibited transactions in the case of trusts 
benefitting certain owner-employees after December 31, 1962, but prior 
to January 1, 1975. See also section 2003 (c)(1)(B) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 978) in the case of an 
organization described in section 401(a) with respect to which a 
disqualified person elects to pay a tax in the amount and manner 
provided with respect to the tax imposed by section 4975 of the Code so 
that the organization may avoid denial of exemption under section 503. 
For further guidance regarding the definition of last known address, see 
Sec. 301.6212-2 of this chapter.
    (d) The application of section 503(b) may be illustrated by the 
following examples:

    Example 1. A creates a foundation in 1954 ostensibly for educational 
purposes. B, a trustee, accumulates the foundation's income from 1957 
until 1959 and then uses a substantial part of this accumulated income 
to send A's children to college. The foundation would lose its exemption 
for the taxable years 1957 through 1959 and for subsequent taxable years 
until it regains its exempt status.
    Example 2. If under the facts in Example 1 such private benefit was 
the purpose of the foundation from its inception, such foundation is not 
exempt by reason of the general provisions of section 501(c)(3), without 
regard to the provisions of section 503, for all years since its 
inception, that is, for the taxable years 1954 through 1959 and 
subsequent taxable years, since under section 501(c)(3) the organization 
must be organized and operated exclusively for exempt purposes. See 
Sec. 1.501(c)(3)-1.

[T.D. 7428, 41 FR 34621, Aug. 16, 1976, as amended by T.D. 8939, 66 FR 
2819, Jan. 12, 2001]



Sec. 1.503(b)-1  Prohibited transactions.

    (a) In general. The term prohibited transaction means any 
transaction set forth in section 503(b) engaged in by any organization 
described in paragraph (a) of Sec. 1.503(a)-1. Whether a transaction is 
a prohibited transaction depends on the facts and circumstances of the 
particular case. This section is intended to deny tax-exempt status to 
such organizations which engage in certain transactions which inure to 
the private advantage of (1) the creator of such organization (if it is 
a trust); (2) any substantial contributor to such organization; (3) a 
member of the family (as defined in section 267(c)(4) of an individual 
who is such creator of or such substantial contributor to such 
organization; or (4) a corporation controlled, as set forth in section 
503(b), by such creator or substantial contributor.
    (b) Loans as prohibited transactions under section 503(b)(1)--(1) 
Adequate security. For the purposes of section 503(b)(1), which treats 
as prohibited transactions certain loans by an organization without 
receipt of adequate security and a reasonable rate of interest, the term 
adequate security means something in addition to and supporting a 
promise to pay, which is so pledged to the organization that it may be 
sold, foreclosed upon, or otherwise disposed of in default of repayment 
of the loan, the value and liquidity of which security is such that it 
may reasonably be anticipated that loss of principal or interest will 
not result from the loan. Mortgages or liens on property, accommodation 
endorsements of those financially capable of meeting the indebtedness, 
and stock or securities issued by corporations other than the borrower 
may constitute security for a loan to the persons or organizations 
described in section 503(b). Stock of a borrowing corporation does not 
constitute adequate security. A borrower's evidence of indebtedness, 
irrespective of its name, is not security for a loan, whether or not it 
was issued directly to the exempt organization. However, if any such 
evidence of indebtedness provides for security that may be sold, 
foreclosed upon, or otherwise disposed of in default of repayment of the 
loan, there may be adequate security for such loan. If an organization 
subject to section 503(b) purchases debentures issued by a person 
specified in section 503(b), the purchase is considered, for purposes of 
section 503(b)(1), as a loan made by the purchaser to the issuer on the 
date of such purchase. For example, if an exempt organization subject to 
section 503(b) makes a purchase through a registered security exchange 
of debentures

[[Page 58]]

issued by a person described in section 503(b), and owned by an unknown 
third party, the purchase will be considered as a loan to the issuer by 
the purchaser. For rules relating to loan of funds to, or investment of 
funds in stock or securities of, persons described in section 503(b) by 
an organization described in section 401(a), see paragraph (b)(5) of 
Sec. 1.401-1.
    (2) Effective dates. The effective dates for the application of the 
definition of adequate security in paragraph (b)(1) of this paragraph 
are:
    (i) March 15, 1956, for loans (other than debentures) made after 
March 15, 1956;
    (ii) January 31, 1957, for loans (other than debentures) made before 
March 16, 1956, and continued after January 31, 1957;
    (iii) November 8, 1956, for debentures which were purchased after 
November 8, 1956;
    (iv) December 1, 1958, for debentures which were purchased before 
November 9, 1956, and held after December 1, 1958;
    (v) If an employees' pension, stock bonus, or profit-sharing trust 
described in section 401(a) made a loan before March 1, 1954, repayable 
by its terms after December 31, 1955, and which would constitute a 
prohibited transaction if made on or after March 1, 1954, the loan shall 
not constitute a prohibited transaction if held until maturity 
(determined without regard to any extension or renewal thereof);
    (vi) January 1, 1960, for loans (including the purchase of 
debentures) made by supplemental unemployment benefit trusts, described 
in section 501 (c)(17);
    (vii) January 1, 1970, for loans (including the purchase of 
debentures) made by employees' contribution pension plan trusts 
described in section 501(c)(18).
    (3) Certain exceptions to section 503(b)(1). See section 503(e) and 
Sec. 1.503(e)-1, 1.503(e)-2, and 1.503(e)-3 for special rules providing 
that certain obligations acquired by trusts described in section 401(a) 
or section 501(c) (17) or (18) shall not be treated as loans made 
without the receipt of adequate security for purposes of section 
503(b)(1). See section 503(f) and Sec. 1.503(f)-1 for an exception to 
the application of sections 503(b)(1) for certain loans made by 
employees' trusts described in section 401(a).
    (c) Examples. The principles of this section are illustrated by the 
following examples: (Assume that section 503 (e) and (f) are not 
applicable.)

    Example 1. A, creator of an exempt trust subject to section 503, 
borrows $100,000 from such trust in 1960, giving his unsecured 
promissory note. The net worth of A is $1,000,000. The net worth of A is 
not security for such loan and the transaction is a prohibited 
transaction. If, however, the note is secured by a mortgage on property 
of sufficient value, or is accompanied by acceptable collateral of 
sufficient value, or carries with it the secondary promise of repayment 
by an accommodation endorser financially capable of meeting the 
indebtedness, it may be adequately secured. However, subordinated 
debentures bonds of a partnership which are guaranteed by the general 
partners are not adequately secured since the general partners are 
liable for the firm's debt and their guaranty adds no additional 
security.
    Example 2. Assume the same facts as in example 1 except that A's 
promissory note in the amount of $100,000 to the trust is secured by 
property which has a fair market value of $75,000. A's promissory note 
secured to the extent of $75,000 is not adequately secured within the 
meaning of section 503(b)(1) since the security at the time of the 
transaction must be sufficient to repay the indebtedness, interest, and 
charges which may pertain thereto.
    Example 3. Corporation M, a substantial contributor to an exempt 
organization subject to section 503, borrows $150,000 from such 
organization in 1960, giving its promissory note accompanied by stock of 
the borrowing corporation with a fair market value of $200,000. Since 
promissory notes and debentures have priority over stock in the event of 
liquidation of the corporation, stock of a borrowing corporation is not 
adequate security. Likewise, debenture bonds which are convertible on 
default into voting stock of the issuing corporation do not constitute 
adequate security under section 503(b)(1).
    Example 4. B, creator of an exempt trust subject to section 503, 
borrows $100,000 from such trust in 1960, giving his secured promissory 
note at the rate of 3 percent interest. The prevailing rate of interest 
charged by financial institutions in the community where the transaction 
takes place is 5 percent for a loan of the same duration and similarly 
secured. The loan by the trust to the grantor is a prohibited 
transaction since section 503(b)(1) requires both adequate security and 
a reasonable rate of interest. Further, a promise to repay the loan plus 
a percentage of future profits which may be greater than

[[Page 59]]

the prevailing rate of interest does not meet the reasonable rate of 
interest requirement.
    Example 5. N Corporation, a substantial contributor to an exempt 
organization subject to section 503 borrows $50,000 on or after March 
16, 1956, from the organization. If the loan is not adequately secured, 
the organization has committed a prohibited transaction at the time the 
loan was made. If the loan had been made on or before March 15, 1956, 
and is continued after January 31, 1957, it must be adequately secured 
on February 1, 1957, or it will be considered a prohibited transaction 
on that date. However, if the exempt organization were an employees' 
trust, described in section 401(a), and the loan were made before March 
1, 1954, repayable by its terms after December 31, 1955, it would not 
have to be adequately secured on February 1, 1957. Moreover, if the 
exempt organization were a supplemental unemployment benefit trust, 
described in section 501(c)(17), and the loan were made before January 
1, 1960, repayable by its terms after December 31, 1959, it would not 
have to be adequately secured on January 1, 1960.
    Example 6. An exempt organization subject to section 503 purchases a 
debenture issued by O Corporation, which is a substantial contributor to 
the organization. The organization purchases the debenture in an arm's 
length transaction from a third person on or after November 9, 1956. The 
purchase is considered as a loan by the organization to O Corporation. 
The loan must be adequately secured when it is made, or it is considered 
as a prohibited transaction at that time. If the organization purchased 
the debenture before November 9, 1956, and holds it after December 1, 
1958, the debenture must be adequately secured on December 2, 1958, or 
it will then be considered as a prohibited transaction. However, if the 
organization were an employees' trust described in section 401(a), and 
if the debenture were purchased before March 1, 1954, and its maturity 
date is after December 31, 1955, the debenture does not have to be 
adequately secured. Moreover, if the organization were an employees' 
contribution pension plan trust described in section 501(c)(18), and if 
the debenture were purchased before January 1, 1970, and its maturity 
date is after December 31, 1969, the debenture does not have to be 
adequately secured.

[T.D. 7428, 41 FR 34621, Aug. 16, 1976]



Sec. 1.503(c)-1  Future status of organizations denied exemption.

    (a) Any organization described in section 501(c) (3), (17), or (18), 
or an employees' trust described in section 401(a), which is denied 
exemption under section 501(a) by reason of the provisions of section 
503(a), may file, in any taxable year following the taxable year in 
which notice of denial was issued, a claim for exemption. In the case of 
organizations described in section 501(c) (3), (17), or (18), the 
appropriate exemption application shall be used for this purpose, and 
shall be filed with the district director. In the case of an enmployees' 
trust described in section 401(a), the information described in Sec. 
1.404(a)-2 shall be submitted with a letter claiming exemption. All 
employees' trust described in section 401(a) shall submit this 
information to the district director with whom a request for a 
determination as to its qualification under section 401 and exemption 
under section 501 may be submitted under paragraph (s) of Sec. 601.201 
of this chapter (Statement of Procedural Rules). A claim for exemption 
must contain or have attached to it, in addition to the information 
generally required of such an organization claiming exemption as an 
organization described in section 501(c) (17), or (18), or section 
401(a) (or section 501(c)(3) prior to January 1, 1970), a written 
declaration made under the penalities of perjury by principal officer of 
such organization authorized to make such declaration that the 
organization will not knowingly again engage in a prohibited 
transaction, (as defined in section 503(b) (or 4975(c) if such section 
applies to such organization)). In the case of section 501(c)(3) 
organizations which have lost their exemption after December 31, 1969, 
pursuant to section 503, a claim for exemption must contain or have 
attached to it a written agreement made under penalities of perjury by a 
principal officer of such organization authorized to make such agreement 
that the organization will not violate the provisions of chapter 42. In 
addition, such organization must comply with the rules for governing 
instruments as prescribed in Sec. 1.508-3. See Sec. 1.501(a)-1 for 
proof of exemption requirements in general.
    (b) If the Commissioner is satisfied that such organization will not 
knowingly again engage in a prohibited transaction (as defined under 
section 503(b) or 4975(c), as applicable to such organization) or in the 
case of a section 501(c)(3) organization, will not violate

[[Page 60]]

the provisions of chapter 42, and the organization also satisfied all 
the other requirements under section 501(c) (3), (17), or (18), or 
section 401(a), the organization will be so notified in writing. In such 
case the organization will be exempt (subject to the provisions of 
section 501(c)(3), or sections 501(c) (17), (18) or 401(a), and 503, and 
504 when applicable) with respect to the taxable years subsequent to the 
taxable year in which the claim described in section 503(c) is filed. 
Section 503 contemplates that an organization denied exemption because 
of the terms of such section will be subject to taxation for at least 
one full taxable year. For the purpose of this section, the term taxable 
year means the established annual accounting period of the organization; 
or, if the organization has no such established annual accounting 
period, the taxable year of the organization means the calendar year.
    (c) For taxable years beginning after December 31, 1969, the denial 
of an exemption pursuant to this section, for a taxable year prior to 
January 1, 1970, of an organization described in section 501(c)(3) shall 
not cause such organization to cease to be described in section 
501(c)(3) for purposes of part II of subchapter F, chapter 1 and for 
purposes of the application of chapter 42 taxes.
    (d) In the case of an organization described in section 501(c)(3), 
which has lost its exemption pursuant to section 503, and which has not 
notified the Commissioner that it is applying for recognition of its 
exempt status under section 508(a) and this section, no gift or 
contribution made after December 31, 1969, which would otherwise be 
deductible under section 170, 642(c), or 545(b)(2) shall be allowed as a 
deduction. For rules relating to the denial of deductions with respect 
to gifts or contributions made before January 1, 1970, see, Sec. 
1.503(e)-4.

[T.D. 7428, 41 FR 34622, Aug. 16, 1976, as amended by T.D. 7896, 48 FR 
23817, May 27, 1983]



Sec. 1.503(d)-1  Cross references.

    For provisions relating to loans described in section 503(b)(1) by a 
trust described in section 401(a), see Sec. 1.503(b)-1 and section 503 
(e) and (f) and the regulations thereunder.

[T.D. 7428, 41 FR 34623, Aug. 16, 1976]



Sec. 1.503(e)-1  Special rules.

    (a) In general. (1) Section 503(e) provides that for purposes of 
section 503(b)(1) (relating to loans made without the receipt of 
adequate security and a reasonable rate of interest) the acquisition of 
a bond, debenture, note, or certificate or other evidence of 
indebtedness shall not be treated as a loan made without the receipt of 
adequate security if certain requirements are met. Those requirements 
are described in Sec. 1.503(e)-2.
    (2) Section 503(e) does not affect the requirement in section 
503(b)(1) of a reasonable rate of interest. Thus, although the 
acquistion of a certificate of indebtedness which meets all of the 
requirements of section 503(e) and of Sec. 1.503(e)-2 will not be 
considered as a loan made without the receipt of adequate security, the 
acquisition of such an indebtedness does consitute a prohibited 
transaction if the indebtedness does not bear a reasonable rate of 
interest.
    (3) The provisions of section 503(e) do not limit the effect of 
section 401(a) and Sec. 1.401-2, section 501(c)(17)(A)(i), or section 
501(c)(18)(A), all relating to the use of diversion of corpus or incopme 
of the respective employee trusts. Furthermore, the provisions of 
section 503(e) do not limit the effect of any of the provisions of 
section 503 other than section 503(b)(1). Thus, for example, although a 
loan made by employees' trust described in section 503(a)(1)(B) meets 
all the requirements of section 503(e) and therefore is not treated as a 
loan made without the receipt of adequate security, such an employees' 
trust making such a loan will lose its exempt status if the loan is not 
considered as made for the exclusive benefit of the employees or their 
beneficiaries. Similarly, a loan which meets the requirements of section 
503(e) will constitute a prohibited transaction within the meaning of 
section 503(b)(6) if it results in a substantial diversion of the 
trust's income or corpus to a person described in section 503(b).
    (b) Definitions. For purposes of section 503(e):

[[Page 61]]

    (1) The term obligation means bond, debenture, note, or certificate 
or other evidence of indebtedness.
    (2) The term issuer includes any person described in section 503(b) 
who issues an obligation.
    (3)(i) The term person independent of the issuer means a person who 
is not related to the issuer by blood, by marriage, or by reason of any 
substantial business interests. Persons who will be considered not to be 
independent of the issuer include but are not limited to:
    (a) The spouse, ancestor, lineal descendant, or brother or sister 
(whether by whole or half blood) of an individual who is the issuer of 
an obligation;
    (b) A corporation controlled directly or indirectly by an individual 
who is the issuer, or directly or indirectly by the spouse, ancestor, 
lineal descendant, or brother or sister (whether by whole or half blood) 
of an individual who is the issuer;
    (c) A corporation which directly or indirectly controls, or is 
controlled by, a corporate issuer;
    (d) A controlling shareholder of a corporation which is the issuer, 
or which controls the issuer;
    (e) An officer, director, or other employee of the issuer, of a 
corporation controlled by the issuer, or of a corporation which controls 
the issuer;
    (f) A fiduciary of any trust created by the issuer, by a corporation 
which controls the issuer, or by a corporation which is controlled by 
the issuer; or
    (g) A corporation controlled by a person who controls a corporate 
issuer.
    (ii) For purposes of paragraph (b)(3)(i) of this section, the term 
control means, with respect to a corporation, direct or indirect 
ownership of 50 percent or more of the total combined voting power of 
all voting stock or 50 percent or more of the total value of shares of 
all classes of stock. If the aggregate amount of stock in a corporation 
owned by an individual and by the spouse, ancestors, lineal descendants, 
brothers and sisters (whether by whole of half blood) of the individual 
is 50 percent or more of the total combined voting power of all voting 
stock or is 50 percent or more of the total value of all classes of 
stock, then each of these persons shall be considered as the controlling 
shareholder of the corporation.
    (iii) In determining family relationships for purposes of paragraph 
(b)(3)(i) of this section, a legally adopted child of an individual 
shall be treated as a child of such individual by blood.
    (4) The term issue means all the obligations of an issuer which are 
offered for sale on substantially the same terms. Obligations shall be 
considered offered for sale on substantially the same terms if such 
obligation would, at the same time and under the same circumstances, be 
traded on the market at the same price. On the other hand, if the terms 
on which obligations are offered for sale differ in such manner as would 
cause such obligations to be traded on the market at different prices, 
then such obligations are not part of the same issue. The following are 
examples of terms which, if different, would cause obligations to be 
traded on the market at different prices: (i) Interest rate; (ii) 
Maturity date; (iii) Collateral; and (iv) Conversion provisions


The fact that obligations are offered for sale on different dates will 
not preclude such obligations from being part of the same issue if they 
all mature on the same date and if the terms on which they are offered 
for sale are otherwise the same, since such obligations would, at the 
same time and under the same conditions, be traded on the market at the 
same price. Obligations shall not be considered part of the same issue 
merely because they are part of the same authorization or because they 
are registered as part of the same issue with the Securities and 
Exchange Commission.

[T.D. 7428, 41 FR 34623, Aug. 16, 1976]



Sec. 1.503(e)-2  Requirements.

    (a) In general. The requirements which must be met under section 
503(e) for an obligation not to be treated as a loan made without the 
receipt of adequate security for purposes of section 503(b)(1) are 
described in paragraphs (b), (c), and (d) of this section. For purposes 
of this section, the term employee trust shall mean any of the three 
kinds of organizations described in section 503(a)(1).
    (b) Methods of acquisition--(1) In general. The employee trust must 
acquire

[[Page 62]]

the obligation of the market, by purchase from an underwriter, or by 
purchase from the issuer, in the manner described in subparagraph (2), 
(3), or (4) of this paragraph.
    (2) On the market. (i) An obligation is acquired on the market when 
it is purchased through a national securities exchange which is 
registered with the Securities and Exchange Commission, or when it is 
purchased in an over-the-counter transaction. For purposes of the 
preceding sentence, securities purchased through an exchange which is 
not a national securities exchange registered with the Securities and 
Exchange Commission shall be treated as securities purchased in an over-
the-counter transaction.
    (ii)(a) If the obligation is listed on a national securities 
exchange registered with the Securities and Exchange Commission, it must 
be purchased through such an exchange or in an over-the-counter 
transaction at a price not greater than the price of the obligation 
prevailing on such an exchange at the time of the purchase by the 
employee trust.
    (b) For purposes of section 503(e), the price of the obligation 
prevailing at the time of the purchase means the price which accurately 
reflects the market value of the obligation. In the case of an 
obligation purchased through a national securities exchange which is 
registered with the Securities and Exchange Commission, the price paid 
for the obligation will be considered the prevailing price of the 
obligation. In the case of an obligation purchased in an over-the-
counter transaction, the prevailing price may be the price at which the 
last sale of the obligation was affected on such national securities 
exchange immediately before the employee trust's purchase of such 
obligation on the same day or may be the mean between the highest and 
lowest prices at which sales were effected on such exchange on the same 
day or on the immediately preceding day or on the last day during which 
there were sales of such obligation or may be a price determined by any 
other method which accurately reflects the market value of the 
obligation.
    (iii)(a) If the obligation is not listed on a national securities 
exchange which is registered with the Securities and Exchange 
Commission, it must be purchased in an over-the-counter transaction at a 
price not greater than the offering price for the obligation as 
established by current bid and asked prices quoted by persons 
independent of the issuer.
    (b) For purposes of section 503(e) the offering price for the 
obligation at the time of the purchase means the price which accurately 
reflects the market value of the obligation. The offering price may be 
the price at which the last sale of the obligation to a person 
independent of the issuer was effected immediately before the employee 
trust's purchase of such obligation on the same day or may be the mean 
between the highest and lowest prices at which sales to persons 
independent of the issuer were effected on the same day or on the last 
day during which they were sales of such obligation or may be a price 
determinated by any other method which accurately reflects the market 
value of the obligation. The offering price for an obligation must be a 
valid price for the amount of the obligations which the trust is 
purchasing. For example, if an employees' trust described in section 
503(a)(1)(B) purchases 1,000 bonds of the employer corporation at the 
offering price established by current prices for a lot of 10 such bonds, 
such offering price may not be a valid price for 1,000 bonds and the 
purchase may therefore not meet the requirements of this subdivision. 
For a purchase of an obligation to qualify under this subdivision, there 
must be sufficient current prices quoted by persons independent of the 
issuer to establish accurately the current value of the obligation. 
Thus, if there are no current prices quoted by persons independent of 
the issuer, an over-the-counter transaction will not qualify under this 
subparagraph even though the obligation was purchased in an arms's 
length transaction from a person independent of the issuer.
    (iv) For purposes of this section, an over-the-counter transaction 
is one not executed on a national securities exchange which is 
registered with the Securities and Exchange Commission. An over-the-
counter transaction may be made through a dealer or an exchange

[[Page 63]]

which is not such a national securities exchange or may be made directly 
from the seller to the purchaser.
    (3) From an underwriter. An obligation may be purchased from an 
underwriter if it is purchased at a price not greater than:
    (i) The public offering price for the obligation as set forth in a 
prospectus or offering circular filed with the Securities and Exchange 
Commission, or
    (ii) The price at which a substantial portion of the issue including 
such obligation is acquired by persons independent of the issuer


whichever is the lesser price. For purposes of this subparagraph, a 
portion of the issue will be considered substantial if the purchasers of 
such portion by persons independent of the issuer are sufficient to 
establish that fair market value of the obligations included in such 
issue. In determining whether the purchases are sufficient to establish 
the fair market value, all the surrounding facts and circumstances will 
be considered, including the number of independent purchasers, the 
aggregate amount purchased by each such independent purchaser, and the 
number of transactions. In the case of a large issue, purchases of a 
small percentage of the outstanding obligations may be considered 
purchases of a substantial portion of the issue; whereas, in the case of 
a small issue, purchases of a larger percentage of the outstanding 
obligations will ordinarily be required. The requirement in paragraph 
(b)(3)(ii) of this section contemplates purchase of the obligations by 
persons independent of the issuer contemporaneously with the purchase by 
the employee trust. If a substantial portion has been purchased at 
different prices, the price of the portion may be based on the average 
of such prices, and if several substantial portions have been sold to 
persons independent of the issuer, the price of any of the substantial 
portions may be used for pusposes of this subparagraph.
    (4) From the issuer. An obligation may be purchased directly from 
the issuer at a price not greater than the price paid currently for a 
substantial portion of the same issue by persons independent of the 
issuer. This requirement contemplates purchase of a substantial portion 
of the same issue by persons independent of the issuer contemporaneously 
with the purchase by the employee trust. For purposes of this 
subparagraph, a portion of the issue will be considered substantial if 
the purchases of such portion by persons independent of the issuer are 
sufficient to establish the fair market value of the obligations 
included in such issue. In determining whether the purchases are 
sufficient to establish the fair market value, all the surrounding facts 
and circumstances will be considered, including the number of 
independent purchasers, the aggregage amount purchased by each such 
independent purchaser, and the number of transactions. In the case of a 
large issue, purchases of a small percentage of the outstanding 
obligations may be considered purchases of a substantial portion of the 
issue; whereas, in the case of a small issue, purchases of a larger 
percentage of the outstanding obligations will ordinarily be required. 
The price paid for a substantial portion of the issue may be determined 
in the manner privided in paragraph (b)(3) of this section.
    (c) Limitations on holdings of obligations. (1) Immediately 
following acquisition of the obligation by the employee trust:
    (i) Not more than 25 percent of the aggregate amount of the 
obligations issued in such issue and outstanding immediately after 
acquisition by the trust may be held by the trust, and
    (ii) At least 50 percent of such aggregate amount must be held by 
persons independent of the issuer.
    (2)(i) For purposes of paragraph (c)(1) of this section, an 
obligation is not considered as outstanding if it is held by the issuer. 
For example, if an obligation which has been issued and outstanding is 
repurchased and held by the issuer, without cancellation or retirement, 
such an obligation is not considered outstanding.
    (ii) For purposes of paragraph (c)(1) of this section, the amounts 
of the obligations held by the trust and by persons independent of the 
issuer shall be computed on the basis of the face amount of the 
obligations.
    (d) Limitation on amount invested in obligations. (1)(i) Immediately 
following

[[Page 64]]

acquisition of the obligation, not more 25 percent of the assets of the 
employee trust may be invested in all obligations of all persons 
described in section 503(b). For purposes of determining the amount of 
the trust's assets which are invested in obligations of persons 
described in section 503(b) immediately following acquisition of the 
obligation, those obligations shall be valued as follows:
    (a) Those obligations included in the acquisition in respect of 
which the percentage test in the first sentence of this subdivision is 
being applied shall be valued at their adjusted basis, as provided in 
section 1011, relating to adjusted basis for determining gain or loss; 
and
    (b) All other obligations of persons described in section 503(b) 
which were part of the trust's assets immediately before the acquisition 
of the obligations described in (d)(1)(i)(a) of this section shall be 
valued at their fair market value on the day that the obligations 
described in (d)(1)(i)(a) of this section were acquired. For purposes of 
determining the total amount of the assets of the trust (including 
obligations of persons described in section 503(b)), there shall be used 
the fair market value of those assets on the day the obligation is 
acquired.
    (ii) The application of the rules in paragraph (d)(1)(i) of this 
section may be illustrated by the following example:

    Example. On February 1, 1960, an exempt employees' trust described 
in section 401(a) purchases unsecured debentures issued by the employer 
corporation for $1,000. At the time of this purchase, such debentures 
have a fair market value of $1,200. Immediately after the purchase of 
such unsecured debentures, the assets of the trust consist of the 
following:

------------------------------------------------------------------------
                                                                 Fair
                                                                market
                                                     Cost      value on
                                                                Feb. 1,
                                                                 1960
------------------------------------------------------------------------
(a) Assets other than obligations of persons          $5,000      $7,800
 described in sec. 503(b).......................
(b) Obligations of persons described in sec.             500       1,000
 503(b) acquired before Feb. 1, 1960............
(c) Unsecured debentures of employer purchased         1,000       1,200
 on Feb. 1, 1960................................
------------------------------------------------------------------------

    Immediately following acquisition of the unsecured debentures by the 
trust, the percent of the assets of the trust that are invested in all 
obligations of all persons described in section 503(b) is computed as 
follows:

(1) Obligations of persons described in section 503(b)            $1,000
 acquired before Feb. 1, 1960 (valued at fair market value).
(2) Unsecured debentures of employer purchased on Feb. 1,          1,000
 1960 (valued at cost)......................................
                                                             -----------
(3) Total amount of trust's assets invested in obligations         2,000
 of persons described in section 503(b) ((1) plus (2))......
                                                             ===========
(4) Assets of the trust other than obligations of persons          7,800
 described in section 503(b) (valued at fair market value on
 Feb. 1, 1960)..............................................
(5) Obligations of persons described in section 503(b)             1,000
 acquired before Feb. 1, 1960 (valued at fair market value
 on Feb. 1, 1960)...........................................
(6) Unsecured debentures of employer purchased on Feb. 1,         $1,200
 1960 (valued at fair market value on Feb. 1, 1960).........
                                                             -----------
(7) Total assets of the trust valued at fair market value on      10,000
 Feb. 1, 1960 (sum of (4), (5), and (6))....................
(8) Percent of assets of the trust invested in all                   20%
 obligations of all persons described in section 503(b)
 immediately following purchase of unsecured debentures on
 Feb. 1, 1960 ((3)/(7), that is, $2,000/$10,000)............
 

    (2) In determining for purposes of subparagraph (1) of this 
paragraph the amount invested in obligations of persons described in 
section 503(b), there shall be included amounts invested in any 
obligations issued by any such person, irrespective of whether the 
obligation is secured, and irrespective of whether the obligation meets 
the conditions of section 503(e) or section 503(f). Obligations of 
persons described in section 503(b) other than the issuer of the 
obligation to which section 503(e) applies are also included within the 
25 percent limitation. For example, if on February 19, 1959, an exempt 
employees' trust described in section 401(a) purchases unsecured 
debentures issued by the employer corporation in a transaction effected 
on the New York Stock Exchange, and if immediately after the purchase 10 
percent of the trust's assets is invested in such debentures and 20 
percent of its assets is invested in a loan made with adequate security 
on January 12, 1959, to the wholly-owned subsidiary of the employer 
corporation, then the purchase of the employer's debentures will not 
qualify under section 503(e), since 30 percent of the trust's assets are 
then

[[Page 65]]

invested in obligations of persons described in section 503(b).
    (e) Change of terms of an obligation. A change in terms of an 
obligation is considered as the acquisition of a new obligation. If such 
new obligation is not adequately secured, the requirements of section 
503(e) must be met at the time the terms of the obligation are changed 
for such section to be applicable to such new loan.

[T.D. 7428, 41 FR 34624, Aug 16, 1976]



Sec. 1.503(e)-3  Effective dates.

    (a) Section 503(e) and Sec. Sec. 1.503(e)-1 and 1.503(e)-3 are 
effective in the case of an employees' trust described in section 401(a) 
for taxable years ending after March 15, 1956. Thus, if during a taxable 
year ending before March 16, 1956, an employees' trust made a loan which 
meets the requirements of section 503(e), such loan will not be treated 
as made without the receipt of adequate security and will not cause the 
loss of exemption for taxable years ending after March 15, 1956, 
although such loan was not considered adequately secured when made. 
(However, section 503 does not apply to organizations described in 
section 401(a) not referred to in section 4975(g) (2) or (3) for 
transactions occurring after December 31, 1974.)
    (b)(1) In the case of obligations acquired by an employees' trust 
described in section 401(a) before September 2, 1958, which were held on 
that date, the requirements described in paragraphs (c) and (d) of Sec. 
1.503(e)-2 which were not satisfied immediately following the 
acquisition shall be treated as satisfied at that time if those 
requirements would have been satisfied had the obligations been acquired 
on September 2, 1958. For example, on January 3, 1955, an employees' 
trust described in section 401(a) purchased through the New York Stock 
Exchange unsecured debentures issued by the employer corporation. Under 
section 503(e) the acquisition of such debentures by the trust will not 
be treated for taxable years ending after March 15, 1956, as a loan made 
without the receipt of adequate security if the debentures were held by 
the employees' trust on September 2, 1958, and if the requirements of 
paragraphs (c) and (d) of Sec. 1.503(e)-2 which were not met on January 
3, 1955, were met on September 2, 1958, as if that date were the date of 
acquisition.
    (2) In the case of obligations acquired before September 2, 1958, 
which were not held by the employees' trust described in section 401(a) 
on that date, only the requirements described in paragraph (b) of Sec. 
1.503(e)-2 must be satisfied for section 503(e) to be applicable to such 
acquisition. For example, if on December 5, 1956, an employees' trust 
lent money to the employer corporation by purchasing a debenture issued 
by the employer and if the trust sold the debenture on August 1, 1958, 
such loan would not be treated as made without the receipt of adequate 
security if the requirement described in paragraph (b) of Sec. 
1.503(e)-2 was met on December 5, 1956.
    (c) Section 503(e) and Sec. Sec. 1.503(e)-1 and 1.503(e)-2 are 
effective in the case of trusts described in section 501(c)(17) with 
respect to loans made, renewed, or, in the case of demand loans, 
continued after December 31, 1959, and in the case of trusts described 
in section 501(c)(18) with respect to loans made, renewed or, in the 
case of demand loans, continued after December 31, 1969.
    (d) See paragraph (b)(2) of Sec. 1.503(b)-1 for the effective dates 
for the application of the definition of adequate security.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]



Sec. 1.503(e)-4  Disallowance of charitable deductions for certain gifts made 

before January 1, 1970.

    Paragraphs (a), (b), and (c) of this section shall apply only to 
gifts or contributions made before January 1, 1970, to an organization 
described in section 501(c)(3). For rules relating to the denial of 
deductions with respect to gifts or contributions made after December 
31, 1969, see Sec. 1.503(c)-1(d).
    (a) No gift or contribution which would otherwise be allowable as a 
charitable or other deductions under section 170, 642(c), or 545(b)(2) 
shall be allowed as a deduction if made to an organization described in 
section 501(c)(3) which at the time the gift or contribution is made is 
not exempt under section 501(a) by reason of the provisions of section 
503.

[[Page 66]]

    (b) If an organization which is described in section 501(c)(3) is 
not exempt because it engaged in a prohibited transaction involving a 
substantial part of its income of corpus with the purpose of diverting 
its income or corpus from its exempt purposes, and if the organization 
receives a gift or contribution during, or prior to, its taxable year in 
which such prohibited transaction occurred, then a deduction by the 
donor with respect to the gift or contribution shall not be disallowed 
under section 503(b) unless the donor (or any member of his family if 
the donor is an individual) is a party to such prohibited transaction. 
For the purpose of the preceding sentence family is defined in section 
267(c)(4) and includes brothers and sisters, whether by whole or half 
blood, spouse, ancestors, and lineal descendants. See the regulations 
under section 267(c).
    (c) The application of Sec. 1.503(e)-4 may be illustrated by the 
following example:

    Example. In 1954, Corporation M, which files its income tax returns 
on the calendar year basis, creates a foundation purportedly for 
charitable purposes and deducts from its gross income for that year the 
amount of the gift to the foundation. Corporation M makes additional 
gifts to this foundation in 1955, 1956, and 1957, and takes charitable 
deductions for such years. B, an individual, also contributes to the 
foundation in 1955, 1956, and 1957, and takes charitable deductions for 
such years. In 1955, the foundation commences purposely to divert its 
corpus to the benefit of Corporation M, and a substantial amount of such 
corpus is so diverted by the close of the taxable year 1956. For 1955 
and subsequent taxable years, the exemption allowed the foundation as an 
organization described in section 501(c)(3) is denied by reason of the 
provisions of section 503(a). Both Corporation M and individual B would 
be disallowed any deduction for the contributions made during 1957 to 
the foundation. Moreover, the charitable deductions taken by Corporation 
M for contributions to the foundation in the years 1955 and 1956 would 
also be disallowed since Corporation M was a party to the prohibited 
transactions. If the facts and surrounding cuircumstances indicate that 
the contribution in 1954 by Corporation M was for the purpose of the 
prohibited transaction, then the charitable deduction for the year 1954 
shall also be disallowed with respect to Corporation M, since the 
prohibited transaction would then have commenced with the making of such 
contribution and the exemption allowed the foundation would then be 
denied for 1954 by reason of the provisions of Sec. 1.503(e)-4. B's 
deductions for his contributions for the years 1955 and 1956 will not be 
disallowed since he was not a party to the prohibited transaction.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]



Sec. 1.503(f)-1  Loans by employers who are prohibited from pledging assets.

    (a) In general. (1) Section 503(f) provides that section 503(b)(1) 
shall not apply to a loan made to the employer by an employees' trust 
described in section 401(a) if the loan bears a reasonable rate of 
interest and certain conditions are met. Section 503(f) also applies to 
the renewal of loans to the employer and, in the case of demand loans, 
to the continuation of such loans.
    (2) The provisions of section 503(f) do not limit the effect of 
section 401(a) and Sec. 1.401-2, relating to use or diversion of corpus 
or income of an employees' trust, or the effect of any of the provisions 
of section 503 other than section 503(b)(1). Consequently, although a 
loan made by an employees' trust described in section 503(a)(1)(B) meets 
all the requirements of section 503(f) and therefore is not treated as a 
loan made without the receipt of adequate security, an employees' trust 
making such a loan will lose its exempt status if the loan is not 
considered as made for the exclusive benefit of the employees or their 
beneficiaries. Similarly, a loan which meets the requirements of section 
503(f) will constitute a prohibited transaction within the meaning of 
section 503(b)(6) if it results in a substantial diversion of the 
trust's income or corpus to a person described in section 503(b).
    (b) Conditions. (1) Section 503(f) applies to a loan only if, with 
respect to the making or renewal of the loan, the conditions described 
in paragraphs (b) (2), (3), and (4) of this section are met. For purpose 
of this paragraph, the mere continuance of a demand loan is not 
considered as the making or renewal of such a loan.
    (2) The employer must be prohibited (at the time of the making or 
renewal of the loan) by any law of the United States or regulations 
thereunder from directly or indirectly pledging, as security for such a 
loan, a particular class

[[Page 67]]

or classes of his assets the value of which (at such time) represents 
more than one-half of the value of all his assets. If a loan is made or 
renewed when the employer is prohibited by a law of the United States 
(or the regulations thereunder) from pledging a class of his assets, the 
qualification of such a loan under section 503(f) will not be affected 
by a subsequent change in such law or regulations permitting the 
employer to pledge such assets, unless such loan is renewed after such 
change. See section 8(a) of the Securities Exchange Act of 1934, as 
amended (15 U.S.C. 78h(a)), which prohibits certain persons from 
pledging a class of assets as security for loans, and 12 CFR 220.5(a) 
(credit by brokers, dealers, and members of national securities 
exchanges).
    (3) The making or renewal, as the case may be, must be approved in 
writing as an investment which is consistent with the exempt purposes of 
the trust by a trustee who is independent of the employer, and such 
written approval must not have been previously refused by any other such 
trustee. A trustee is independent of the employer, for purposes of this 
subparagraph, if he is entirely free of influence or controlled by the 
employer. For example, if the employer is a partnership, then a partner 
in such partnership, or a member of a partner's family would not be 
considered independent of the employer. Similarly, an employee of the 
employer would not be considered independent of the employer. For 
purposes of this subparagraph, the term trustee means, with respect to 
any trust for which there are two trustees who are independent of the 
employer, both of such trustees and, with respect to any trust for which 
there are more than two such independent trustees, a majority of the 
trustees independent of the employer.
    (4)(i) Immediately following the making or renewal, as the case may 
be, the aggregate amount lent by the trust to the employer, without the 
receipt of adequate security must not exceed 25 percent of the value of 
all the assets of the trust.
    (ii) For purposes of paragraph (b)(4)(i) of this section, the 
determination as to whether any amount lent by the trust to the employer 
is a loan made without the receipt of adequate security shall be made 
without regard to section 503(e). Thus, if an employees' trust makes a 
loan on January 2, 1959, to the employer without adequate security (but 
which loan is not considered as made without adquate security under 
section 503(e)), and if immediately after making such loan 10 percent of 
the value of all its assets is invested in such loan, then the trust may 
on that day invest not more than an additional 15 percent of its assets 
in a loan which would be considered made without adequate security if it 
were not for the provisions of section 503(f).
    (iii) For purposes of paragraph (b)(4)(i) of this section, in 
determining the value of all the assets of the trust, there shall be 
used the fair market value of those assets on the day of the making or 
renewal.
    (c) Reasonable rate of interest. Section 503(f) only applies if, in 
addition to meeting the conditions described in paragraph (b) of this 
section, the loan bears a reasonable rate of interest when it is made, 
renewed, or, in the case of demand loans, during the period of its 
existence.
    (d) Change of terms of loan. A change in the terms of a loan 
(including a reduction in the security for a loan) is considered as the 
making of a new loan. If such a new loan is not adequately secured, the 
requirements of section 503(f) must be met at the time the terms of the 
loan are changed for such section to be applicable to such new loan.
    (e) Effective date. (1) This section and section 503(f) are 
effective for taxable years ending after September 2, 1958, but only 
with respect to periods after such date. Thus, if a loan was made on or 
before September 2, 1958, without the receipt of adequate security and 
if, when such loan was made, it met all of the requirements of section 
503(f) and this section, then the loan is not subject to section 
503(b)(1) after September 2, 1958, and would not consitite a prohibited 
transaction after that date because of a lack of adequate security.
    (2) See paragraph (b)(2) of Sec. 1.503(b)-1 for the effective dates 
for application of the definition of adequate security.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]

[[Page 68]]



Sec. 1.504-1  Attempts to influence legislation; certain organizations 

formerly described in section 501(c)(3) denied exemption.

    Section 504(a) and this section apply to an organization that is 
exempt from taxation at any time after October 4, 1976, as an 
organization described in section 501(c)(3), and that ceases to be 
described in that section because it--
    (a) Is an action organization within the meaning of Sec. 
1.501(c)(3)-1(c)(3)(ii) or (iv), on account of activities occurring 
after October 4, 1976, or
    (b) Is denied exemption under the provisions of section 501(h) (see 
Sec. 1.501(h)-3 or Sec. 56.4911-9).

This section does not apply, however, to an organization that was 
described in section 501(h)(5) and Sec. 1.501(h)-2(b)(3) (relating 
generally to churches) for its taxable year immediately preceding the 
first taxable year for which it is no longer an organization described 
in section 501(c)(3). An organization to which section 504(a) and this 
section apply shall not be treated as described in section 501(c)(4) at 
any time after the organization ceases to be described in section 
501(c)(3). Further, an organization denied treatment as an organization 
described in section 501(c)(4) under this section may not be treated as 
an organization described in section 501(c) other than as an 
organization described in section 501(c)(3). For rules relating to 
recognition of exemption after exemption is denied under section 501(h), 
Sec. 1.501(h)-3(d).

[T.D. 8308, 55 FR 35592, Aug. 31, 1990]



Sec. 1.504-2  Certain transfers made to avoid section 504(a).

    (a) Scope. Under section 504(b), a transfer described in paragraph 
(b) or (c) of this section to an organization exempt from tax under 
section 501(a) may result in loss of exemption by the transferee unless 
the Commissioner determines, under paragraph (e) of this section, that 
the original transfer did not effect an avoidance of section 504(a). For 
purposes of this section, the term transfer includes any use by, or for 
the benefit of, the recipient of the transfer, but does not include any 
transfer made for adequate and full consideration.
    (b) Transferor and transferee commonly controlled--(1) Loss of 
exemption. A transfer is described in this paragraph (b) if it is 
described in paragraphs (b)(2) through (b)(6). The transferee of a 
transfer described in this paragraph will cease to be exempt from tax 
under section 501(a), unless the provisions of paragraph (e) of this 
section apply.
    (2) Transferor organization. A transfer is described in this 
paragraph (b)(2) only if it is from an organization that--
    (i) Is or was described in section 501(c)(3), but not in section 
501(h)(5), and
    (ii) Is determined to be an ``action'' organization (as defined in 
Sec. 1.501(c)(3)-1(c)(3)(ii) or (iv)), or is denied exemption from tax 
by reason of section 501(h) and either Sec. 1.501(h)-3 or Sec. 
56.4911-9.
    (3) Transferor and transferee commonly controlled. A transfer is 
described in this paragraph (b)(3) only if, at the time of the transfer 
or at any time during the transferee's ten taxable years following the 
year in which the transfer was made, the transferee is controlled 
(directly or indirectly), as defined in paragraph (f) of this section, 
by the same person or persons who control the transferor.
    (4) Time of transfer. A transfer is described in this paragraph 
(b)(4) only if the transfer is made--
    (i) After the date that is 24 months before the earliest of the 
effective date of the determination under section 501(h) that the 
transferor is not exempt, the effective date of the Commissioner's 
determination that the transferor is an ``action'' organization (as 
defined in Sec. 1.501(c)(3)(ii) or (iv)), or the date on which the 
Commissioner proposes to treat it as no longer described in section 
501(c)(3), and
    (ii) Before the transferor again is recognized as an organization 
described in section 501(c)(3).
    (5) Transferee. A transfer is described in this paragraph (b)(5) 
only if the transferee is exempt from tax under section 501(a) but the 
transferee is neither--
    (i) An organization described in section 501(c)(3), nor

[[Page 69]]

    (ii) An organization described in section 401(a) to which the 
transferor contributes as an employer.
    (6) Amount of transfer. A transfer is described in this paragraph 
(b)(6) only if the amount of the transfer exceeds the lesser of 30 
percent of the net fair market value of the transferor's assets or 50 
percent of the net fair market value of the transferee's assets, 
computed immediately before the transfer. For purposes of this paragraph 
(b)(6)--
    (i) The amount of a transfer by a transferor is the sum of the 
amounts transferred to any number of transferees in any number of 
transfers, all of which are described in paragraphs (b)(2) through 
(b)(5) of this section, and the time of the transfer is the time of the 
first transfer so taken into account; and
    (ii) The amount of a transfer to a transferee is the sum of the 
amounts transferred by a transferor to the transferee in any number of 
transfers, all of which are described in paragraphs (b)(2) through 
(b)(5) of this section, and the time of the transfer is the time of the 
first transfer so taken into account.
    (c) Other transfers--(1) Transfers included. A transfer is described 
in this paragraph (c) if it would be described in paragraph (b) of this 
section except that either--
    (i) The amount of the transfer is less than the amount determined in 
paragraph (b)(6) of this section, or
    (ii) The transferor and transferee are not commonly controlled as 
described in paragraph (b)(3) of this section, or
    (iii) The transferee is an organization described in sections 
501(c)(3) and 501(h)(4).
    (2) Loss of exemption. The transferee of a transfer described in 
this paragraph (c) will cease to be exempt under section 501(a) if the 
Commissioner determines on all the facts and circumstances that the 
transfer effected an avoidance of section 504(a). In determining whether 
a transfer effected an avoidance of section 504(a), the Commissioner may 
consider whether the transferee engages, or has engaged, in attempts to 
influence legislation and may also consider any factors enumerated in 
paragraph (e) of this section.
    (d) Date of loss of exempt status. A transferee of a transfer 
described in paragraph (b), (c)(1)(ii), or (c)(1)(iii) of this section 
will cease to be exempt from tax under section 501(a) on the date that 
all requirements of paragraph (b), (c)(1)(ii), or (c)(1)(iii) (other 
than the determination by the Commissioner) are satisfied. A transferee 
of a transfer described in paragraph (c)(1)(i) of this section will 
cease to be exempt from tax under section 501(a) on the date of the last 
transfer preceding notification of the transferee that the Commissioner 
proposes to treat the transferee as other than an exempt organization.
    (e) Transfers not in avoidance of section 504(a). Notwithstanding 
paragraph (b) of this section, if, based on all the facts and 
circumstances, the Commissioner determines that a transfer described in 
paragraph (b) did not effect an avoidance of section 504(a), the 
transferee will not be denied exemption from tax by reason of section 
504(b) and this section. In making the determination called for in the 
preceding sentence, the Commissioner may consider all relevant factors 
including:
    (1) Whether enforceable and effective conditions on the transfer 
preclude use of any of the transferred assets for any purpose that, if 
it were a substantial part of an organization's activities, would be 
inconsistent with exemption as an organization described in section 
501(c)(3);
    (2) In the absence of conditions described in paragraph (e)(1) of 
this section, whether the transferred assets are used exclusively for 
purposes that are consistent with the transferor's exemption as an 
organization described in section 501(c)(3);
    (3) Whether the assets transferred would be describe in Sec. 
53.4942(a)(-2(c)(3) before, as well as after, the transfer if both the 
transferor and transferee were private foundations;
    (4) Whether and to what extent the transfer would satisfy the 
provisions of Sec. 1.507-2(a) (7) and (8) if the transferor were a 
private foundation;
    (5) Whether all of the transferred assets have been expended during 
a period when the transferee was not controlled (directly or indirectly) 
by the

[[Page 70]]

same person or persons who controlled the transferor; and
    (6) Whether the entire amount of the transferred assets were in turn 
transferred, before the close of the transferee's taxable year following 
the taxable year in which the transferred assets were received, to one 
or more organizations described in section 507(b)(1)(A) none of which 
are controlled (directly or indirectly) by the same persons who control 
either the original transferor or transferee.
    (f) Control. For purposes of section 504 and the regulations 
thereunder--
    (1) The transferor will be presumed to control any organization with 
which it is affiliated within the meaning of Sec. 56.4911-7(a), or 
would be if both organizations were described in section 501(c)(3), and
    (2) The transferee will be treated as controlled (directly of 
indirectly) by the same person or persons who control the transferor if 
the transferee would be treated as controlled under Sec. 53.4942(a)-
3(a)(3), for which purpose the transferor shall be treated as a private 
foundation.

[T.D. 8308, 55 FR 35592, Aug. 31, 1990]



Sec. 1.505(c)-1T  Questions and answers relating to the notification 

requirement for recognition of exemption under paragraphs (9), (17) and (20) 

of Section 501(c) (temporary).

    Q-1: What does section 505(c) of the Internal Revenue Code provide?
    A-1: Section 505(c) provides that an organization will not be 
recognized as exempt under section 501(c)(9) as a voluntary employees' 
beneficiary association, under section 501(c)(17) as a trust forming 
part of a plan providing for the payment of supplemental unemployment 
compensation benefits, or under section 501(c)(20) as a trust forming 
part of a qualified group legal services plan unless notification is 
given to the Internal Revenue Service. The notification required of a 
trust created pursuant to section 501(c)(20) and forming part of a 
qualified group legal services plan is set forth in Q&A-2. The 
notification required of an organization organized after July 18, 1984, 
and applying for exempt status as an organization described in section 
501(c) (9) or (17) is set forth in Q&A-3 through Q&A-8. The notification 
required of an organization organized on or before July 18, 1984, and 
claiming exemption as an organization described in section 501(c) (9) or 
(17) is set forth in Q&A-9 through Q&A-11. However, an organization that 
has previously notified the Internal Revenue Service of its claim to 
exemption under section 501(c) (9), (17), or (20) or its claim to 
exemption under those sections pursuant to another provision of the 
Code, is not required, under section 505(c), to submit a renotification 
(See Q&A-2 and Q&A-12).

                        Section 501(c)(20) Trusts

    Q-2: What is the notice required of a trust created pursuant to 
section 501(c)(20) and forming part of a qualified group legal services 
plan under section 120?
    A-2: (a) A trust claiming exemption as an organization described in 
section 501(c)(20) will be recognized as exempt if the exclusive 
function of the trust is to form part of a qualified group legal 
services plan or plans. Exemption of the trust under section 501(c)(20) 
will generally be dependent upon and coextensive with recognition of the 
plan as a qualified group legal services plan. Therefore, a trust 
organized pursuant to section 501(c)(20) after July 18, 1984, need not 
file a separate notice with the Internal Revenue Service of its claim to 
exemption because the notice required by section 120(c)(4) will suffice 
for purposes of section 505(c), provided a copy of the trust instrument 
is filed with the Form 1024 submitted by the group legal services plan. 
If the trust instrument has not been filed with the Form 1024 submitted 
by the group legal services plan, the trust must comply with (and 
exemption will be dependent upon) the filing applicable to a trust 
organized on or before July 18, 1984. For the notice required and 
effective dates of exemption of a qualified group legal services plan 
under section 120, see Sec. 1.120-3.
    (b) A trust organized on or before July 18, 1984, that claims exempt 
status as a trust described in section 501(c)(20) and that forms part of 
a qualified group legal services plan which has been recognized as 
exempt under section 120, must file a copy of its trust instrument with 
the Internal Revenue Service before February 4, 1987. If a copy of the 
trust instrument is filed within the time provided, the trust's 
exemption will be recognized retroactively to the date the qualified 
group legal services plan was recognized as exempt under section 120. 
However, if a copy of the trust instrument is filed after the time 
provided, exemption will be recognized only for the period after the 
copy of the trust instrument is filed with the Internal Revenue Service. 
See Q&A-7 for a further discussion of date of filing. A trust that has 
previously filed a copy of its trust instrument with the Service need 
not refile that document.

 Section 501(c)(9) and (17) Organizations Organized After July 18, 1984

    Q-3: What is the notice required of an organization or trust, 
organized after July 18,

[[Page 71]]

1984, that is applying for recognition of tax exempt status under 
section 501(c) (9) or (17)?
    A-3: An organization or trust that is organized after July 18, 1984, 
will not be treated as described in paragraphs (9) or (17) of section 
501(c), unless the organization notifies the Internal Revenue Service 
that it is applying for recognition of exemption. In addition, unless 
the required notice is given in the manner and within the time 
prescribed by these regulations, an organization will not be treated as 
exempt for any period before the giving of the required notice. The 
notice is filed by submitting a properly completed and executed Form 
1024, ``Application for Recognition of Exemption Under Section 501(a) or 
for Determination Under Section 120'' together with the additional 
information required under Q&A-4 and Q&A-5. The notice is filed with the 
district director for the key district in which the organization's 
principal place of business or principal office is located.
    The notice may be filed by either the plan administrator (as defined 
in section 414(g)) or the trustee. The Internal Revenue Service will not 
accept a Form 1024 for any organization or trust before such entity has 
been organized.
    Q-4: What information, in addition to the information required by 
Form 1024, must be submitted by an organization or trust seeking 
recognition of exemption under section 501(c) (9) or (17)?
    A-4: A notice will not be considered complete unless, in addition to 
a properly completed and executed Form 1024, the organization or trust 
submits a full description of the benefits available to participants 
under section 501(c) (9) or (17). Moreover, both the terms and 
conditions of eligibility for membership and the terms and conditions of 
eligibility for benefits must be set forth. This information may be 
contained in a separate document, such as a plan document, or it may be 
contained in the creating document of the entity (e.g., the articles of 
incorporation or association, or a trust indenture). For benefits 
provided through a policy or policies of insurance, all such policies 
must be included with the notice. Where individual policies of insurance 
are provided to the participants, single exemplar copies, typical of 
policies generally issued to participants, are acceptable, provided they 
adequately describe all forms of insurance available to participants. In 
providing a full description of the benefits available, the benefits 
provided must be sufficiently described so that each benefit is 
definitely determinable. A benefit is definitely determinable if the 
amount of the benefit, its duration, and the persons eligible to receive 
it are ascertainable from the plan document or other instrument. Thus, a 
benefit is not definitely determinable if the rules governing either its 
amount, its duration, or its recipients are not ascertainable from the 
plan document or other instrument but are instead subject to the 
discretion of a person or committee. Likewise, a benefit is not 
definitely determinable if the amount for any individual is based upon a 
percentage share of any item that is within the discretion of the 
employer. However, a disability benefit will not fail to be considered 
definitely determinable merely because the determination of whether an 
individual is disabled is made under established guidelines by an 
authorized person or committee.
    Q-5: What is the notice required of collectively bargained plans?
    A-5: If an organization or trust claiming exemption under section 
501(c) (9) or (17) is organized and maintained pursuant to a collective 
bargaining agreement between employee representatives and one or more 
employer, only one Form 1024 is required to be filed for the 
organization or trust, regardless of the number of employers originally 
participating in the agreement. Moreover, once a Form 1024 is filed 
pursuant to a collective bargaining areement, an additional Form 1024 is 
not required to be filed by an employer who thereafter participates in 
that agreement. When benefits are provided pursuant to a collective 
bargaining agreement, the notice will not be considered complete unless, 
in addition to a properly completed and executed Form 1024, a copy of 
the collective bargaining agreement is also submitted together with the 
additional information delineated in Q&A-4.
    Q-6: When must the required notice be filed by an organization or 
trust, organized after July 18, 1984, that seeks recognition of 
exemption under section 501(c) (9) or (17)?
    A-6: An organization or trust applying for exemption must file the 
required notice by the later of February 4, 1987 or 15 months from the 
end of the month in which the organization or trust was organized. An 
extension of time for filing the required notice may be granted by the 
district director if the request is submitted before the end of the 
applicable period and it is demonstrated that additional time is needed.
    Q-7: What is the effective date of exemption for a new organization 
or trust, organized after July 18, 1984, that has submitted the required 
notice?
    A-7: If the required notice is filed within the time provided by 
these regulations, the organization's exemption will be recognized 
retroactively to the date the organization was organized, provided its 
purpose, organization and operation (including compliance with the 
applicable nondiscrimination requirements) during the period prior to 
the date of the determination letter are in accordance with the 
applicable law. However, if the required notice is filed after the time 
provided by these regulations, exemption will be recognized only for the 
period after the application is filed with the Internal

[[Page 72]]

Revenue Service. The date of filing is the date of the United States 
postmark on the cover in which an exemption application is mailed or, if 
no postmark appears on the cover, the date the application is stamped as 
received by the Service. If an extension for filing the required notice 
has been granted to the organization, a notice filed on or before the 
last day specified in the extension will be considered timely and not 
the otherwise applicable date under Q&A-6.
    Q-8: What is the effect on exemption of the filing of an incomplete 
notice?
    A-8: Although a properly completed and executed Form 1024 together 
with the required additional information (See Q&A-4 and Q&A-5) must be 
submitted to satisfy the notice required by section 505(c), the failure 
to file, within the time specified, all of the information necessary to 
complete such notice will not alone be sufficient to deny recognition of 
exemption from the date of organization to the date the completed 
information is submitted to the Service. If the notice which is filed 
with the Service within the required time is substantially complete, and 
the organization supplies the necessary additional information requested 
by the Service within the additional time allowed, the original notice 
will be considered timely. However, if the notice is not substantially 
complete or the additional information is not provided within the 
additional time allowed, exemption will be recognized only from the date 
of filing of the additional information.

Section 501(c)(9) and (17) Organizations Organized on or Before July 18, 
                                  1984

    Q-9: What is the notice required of an organization or trust 
organized on or before July 18, 1984, that claims exempt status as an 
organization described in section 501(c) (9) or (17)?
    A-9: Section 505(c) provides a special rule for existing 
organizations and trusts organized on or before July 18, 1984. Such an 
organization or trust will not be treated as described in paragraphs (9) 
or (17) of section 501(c) unless the organization or trust notifies the 
Internal Revenue Service in the manner and within the time prescribed in 
these regulations that it is claiming exemption under the particular 
section. The type of notice, the manner for filing that notice, and the 
additional information required is the same as that set forth in Q&A-3 
through Q&A-5 for new organizations.
    Q-10: When must the required notice be filed by an organization or 
trust organized on or before July 18, 1984?
    A-10: An organization or trust organized on or before July 18, 1984, 
that claims exempt status as an organization described in section 501(c) 
(9) or (17), must file the required notice before February 4, 1987. An 
extension of time for filing the required notice may be granted by the 
district director if the request is submitted before the due date of the 
notice and it is demonstrated that additional time is needed.
    Q-11: What is the effective date of exemption for an organization or 
trust organized on or before July 18, 1984, that has submitted the 
required notice?
    A-11: If the required notice is filed within the time provided by 
these regulations, the organization's exemption will be recognized 
retroactively to the date the organization was organized, provided its 
purpose, organization and operation (including compliance with the 
applicable nondiscrimination requirements) during the period prior to 
the date of the determination letter are in accordance with the 
applicable law. If, on the other hand, the required notice is filed 
after the time provided by these regulations, exemption will be 
recognized only for the period after the notice is received by the 
Internal Revenue Service. See Q&A-7 for a further discussion of date of 
filing. See also Q&A-8 for the effect on exemption of a notice that has 
been timely filed but is incomplete.

                    Exceptions to Notice Requirement

    Q-12: Are any organizations or trusts claiming recognition of 
exemption as an organization described in section 501(c) (9) or (17) 
excepted from the notice requirement of section 505(c)?
    A-12: An organization or trust that has previously notified the 
Internal Revenue Service of its claim to exemption by filing Form 1024 
is not required, under section 505(c), to renotify the Service. Thus, an 
organization that has filed a Form 1024 that is pending with the Service 
need not refile that form. Also, an organization that has received a 
ruling or determination letter from the Service recognizing its 
exemption from taxation need not submit the notification required by 
section 505(c).

[T.D. 8073, 51 FR 4330, Feb. 4, 1986]

                           Private Foundations



Sec. 1.507-1  General rule.

    (a) In general. Except as provided in Sec. 1.507-2, the status of 
any organization as a private foundation shall be terminated only if:
    (1) Such organization notifies the district director of its intent 
to accomplish such termination, or
    (2)(i) With respect to such organization, there have been either 
willful repeated acts (or failures to act), or a willful and flagrant 
act (or failure to act), giving rise to liability for tax under chapter 
42, and

[[Page 73]]

    (ii) The Commissioner notifies such organization that, by reason of 
subdivision (i) of this subparagraph, such organization is liable for 
the tax imposed by section 507(c)


and either such organization pays the tax imposed by section 507(c) (or 
any portion not abated under section 507(g)) or the entire amount of 
such tax is abated under section 507(g).
    (b) Termination under section 507(a)(1). (1) In order to terminate 
its private foundation status under paragraph (a)(1) of this section, an 
organization must submit a statement to the district director of its 
intent to terminate its private foundation status under section 
507(a)(1). Such statement must set forth in detail the computation and 
amount of tax imposed under section 507(c). Unless the organization 
requests abatement of such tax pursuant to section 507(g), full payment 
of such tax must be made at the time the statement is filed under 
section 507(a)(1). An organization may request the abatement of all of 
the tax imposed under section 507(c), or may pay any part thereof and 
request abatement of the unpaid portion of the amount of tax assessed. 
If the organization requests abatement of the tax imposed under section 
507(c) and such request is denied, the organization must pay such tax in 
full upon notification by the Internal Revenue Service that such tax 
will not be abated. For purposes of subtitle F of the Code, the 
statement described in this subparagraph, once filed, shall be treated 
as a return.
    (2) Termination of private foundation status under section 507(a)(1) 
does not relieve a private foundation, or any disqualified person with 
respect thereto, of liability for tax under chapter 42 with respect to 
acts or failures to act prior to termination or for any additional taxes 
imposed for failure to correct such acts or failures to act. See 
subparagraph (8) of this paragraph as to the possible imposition of 
transferee liability in cases not involving termination of private 
foundation status.
    (3) In the case of an organization which has terminated its private 
foundation status under section 507(a) and continues in operation 
thereafter, if such organization wishes to be treated as described in 
section 501(c)(3), then pursuant to section 509(c) and Sec. 1.509(c)-1 
such organization must apply for recognition of exemption as an 
organization described in section 501(c)(3) in accordance with the 
provisions of section 508(a).
    (4) See Sec. 53.4947-1(c)(7) of this chapter as to the application 
of section 507(a) to certain split-interest trusts.
    (5) For purposes of section 508(d)(1), the Internal Revenue Service 
shall make notice to the public (such as by publication in the Internal 
Revenue Bulletin) of any notice received from a private foundation 
pursuant to section 507(a)(1) or of any notice given to a private 
foundation pursuant to section 507(a)(2).
    (6) If a private foundation transfers all or part of its assets to 
one or more other private foundations (or one or more private 
foundations and one or more section 509(a) (1), (2), (3), or (4) 
organizations) pursuant to a transfer described in section 507(b)(2) and 
Sec. 1.507-3(c), such transferor foundation will not have terminated 
its private foundation status under section 507(a)(1). See Sec. 1.507-
3, however, for the special rules applicable to private foundations 
participating in section 507(b)(2) transfers.
    (7) Neither a transfer of all of the assets of a private foundation 
nor a significant disposition of assets (as defined in Sec. 1.507-
3(c)(2)) by a private foundation (whether or not any portion of such 
significant disposition of assets is made to another private foundation) 
shall be deemed to result in a termination of the transferor private 
foundation under section 507(a) unless the transferor private foundation 
elects to terminate pursuant to section 507(a)(1) or section 507(a)(2) 
is applicable. Thus, if a private foundation transfers all of its assets 
to one or more persons, but less than all of its net assets to one or 
more organizations described in section 509(a)(1) which have been in 
existence and so described for a continuous period of 60 calendar 
months, for purposes of this paragraph such transferor foundation will 
not be deemed by reason of such transfer to have terminated its private 
foundation status under section 507 (a) or (b) unless section 507(a)(2) 
is applicable. Such foundation will continue to be treated as a private

[[Page 74]]

foundation for all purposes. For example, if a private foundation 
transfers all of its net assets to a section 509(a)(2) organization in 
1971 and receives a bequest in 1973, the bequest will be regarded as 
having been made to a private foundation and the foundation will be 
subject to the provisions of chapter 42 with respect to such funds. If a 
private foundation makes a transfer of all of its net assets to a 
section 509(a) (2) or (3) organization, for example, it must retain 
sufficient income or assets to pay the tax imposed under section 4940 
for that portion of its taxable year prior to such transfer. For 
additional rules applicable to a transfer by a private foundation of all 
of its net assets to a section 509(a)(1) organization which has not been 
in existence and so described for a continuous period of 60 calendar 
months, see Sec. 1.507-3(e).
    (8) If a private foundation makes a transfer described in 
subparagraph (7) of this paragraph and prior to, or in connection with, 
such transfer, liability for any tax under chapter 42 is incurred by the 
transferor foundation, transferee liability may be applied against the 
transferee organization for payment of such taxes. For purposes of this 
subparagraph, liability for any tax imposed under chapter 42 for failure 
to correct any act or failure to act shall be deemed incurred on the 
date on which the act or failure to act giving rise to the initial tax 
liability occurred.
    (9) A private foundation which transfers all of its net assets is 
required to file the annual information return required by section 6033, 
and the foundation managers are required to file the annual report of a 
private foundation required by section 6056, for the taxable year in 
which such transfer occurs. However, neither such foundation nor its 
foundation managers will be required to file such returns for any 
taxable year following the taxable year in which the last of any such 
transfers occurred, if at no time during the subsequent taxable years in 
question the foundation has either legal or equitable title to any 
assets or engages in any activity.
    (c) Involuntary termination under section 507(a)(2). (1) For 
purposes of section 507(a)(2)(A), the term willful repeated acts (or 
failures to act) means at least two acts or failures to act both of 
which are voluntary, conscious, and intentional.
    (2) For purposes of section 507(a)(2)(A), a willful and flagrant act 
(or failure to act) is one which is voluntarily, consciously, and 
knowingly committed in violation of any provision of chapter 42 (other 
than section 4940 or 4948(a)) and which appears to a reasonable man to 
be a gross violation of any such provision.
    (3) An act (or failure to act) may be treated as an act (or failure 
to act) by the private foundation for purposes of section 507(a)(2) even 
though tax is imposed upon one or more foundation managers rather than 
upon the foundation itself.
    (4) For purposes of section 507(a)(2), the failure to correct the 
act or acts (or failure or failures to act) which gave rise to liability 
for tax under any section of chapter 42 by the close of the correction 
period for such section may be a willful and flagrant act (or failure to 
act).
    (5) No motive to avoid the restrictions of the law or the incurrence 
of any tax is necessary to make an act (or failure to act) willful. 
However, a foundation's act (or failure to act) is not willful if the 
foundation (or a foundation manager, if applicable) does not know that 
it is an act of self-dealing, a taxable expenditure, or other act (or 
failure to act) to which chapter 42 applies. Rules similar to the 
regulations under chapter 42 (see, for example, Sec. 53.4945-
1(a)(2)(iii) of this chapter) shall apply in determining whether a 
foundation or a foundation manager knows that an act (or failure to act) 
is an act of self-dealing a taxable expenditure or other such act (or 
failure to act).

[T.D. 7233, 37 FR 28157, Dec. 21, 1972, as amended by T.D. 7290, 38 FR 
31833, Nov. 19, 1973]



Sec. 1.507-2  Special rules; transfer to, or operation as, public charity.

    (a) Transfer to public charities--(1) General rule. Under section 
507(b)(1)(A) a private foundation, with respect to which there have not 
been either willful repeated acts (or failures to act) or

[[Page 75]]

a willful and flagrant act (or failure to act) giving rise to liability 
for tax under chapter 42, may terminate its private foundation status by 
distributing all of its net assets to one or more organizations 
described in section 170(b)(1)(A) (other than in clauses (vii) and 
(viii)) each of which has been in existence and so described for a 
continuous period of at least 60 calendar months immediately preceding 
such distribution. Since section 507(a) does not apply to such a 
termination, a private foundation which makes such a termination is not 
required to give the notification described in section 507(a)(1). A 
private foundation which terminates its private foundation status under 
section 507(b)(1)(A) does not incur tax under section 507(c) and, 
therefore, no abatement of such tax under section 507(g) is required.
    (2) Effect of current ruling--(i) Distributions before final 
regulations. With respect to distributions made before (insert day after 
the date these regulations are filed by the Office of the Federal 
Register), an organization to which a distribution of net assets is made 
will qualify as an organization described in section 170(b)(1)(A) (other 
than clauses (vii) and (viii)) for purposes of meeting the requirements 
of section 507(b)(1)(A) without a further showing if such distributee 
organization:
    (A) Has been in existence for a continuous period of at least 60 
calendar months preceding the distribution described in subparagraph (1) 
of this paragraph;
    (B) Has received a ruling or determination letter that it is an 
organization described in clause (i), (ii), (iii), (iv), (v), or (vi) of 
section 170(b)(1) (A);
    (C) The facts and circumstances forming the basis for the issuance 
of the ruling have not substantially changed during the 60-month period 
referred to in (A) of this subdivision; and
    (D) The ruling or determination letter referred to in (B) of this 
subdivision has not been revoked expressly or by a subsequent change of 
the law or regulations under which the ruling was issued.
    (ii) Distributions after final regulations. With respect to 
distributions made after December 29, 1972, a private foundation seeking 
to terminate its private foundation status pursuant to section 
507(b)(1)(A) may rely on a ruling or determination letter issued to a 
potential distributee organization that such distributee organization is 
an organization described in clause (i), (ii), (iii), (iv), (v), or (vi) 
of section 170(b)(1)(A) in accordance with the provisions of Sec. 
1.509(a)-7.
    (3) Organizations described in more than one clause of section 
170(b)(1)(A). For purposes of this paragraph and section 507(b)(1)(A), 
the parenthetical term other than in clauses (vii) and (viii) shall 
refer only to an organization which is described only in section 
170(b)(1)(A) (vii) or (viii). Thus, an organization described in clause 
(i), (ii), (iii), (iv), (v), or (vi) of section 170(b)(1)(A) will not be 
precluded from being a distributee described in section 507(b)(1)(A) 
merely because it also appears to meet the description of an 
organization described in section 170(b)(1)(A) (vii) or (viii).
    (4) Applicability of chapter 42 to foundations terminating under 
section 507(b)(1)(A). Except as provided in subparagraph (5) of this 
paragraph, an organization which terminates its private foundation 
status pursuant to section 507(b)(1)(A) will remain subject to the 
provisions of chapter 42 until the distribution of all of its net assets 
to distributee organizations described in section 507(b)(1)(A) has been 
completed.
    (5) Special transitional rule. (i) Section 4940(a) imposes a tax 
upon private foundations with respect to the carrying on of activities 
for each taxable year. For purposes of section 4940, an organization 
which terminates its private foundation status under section 
507(b)(1)(A) by the end of the period described in subdivision (ii) of 
this subparagraph will not be considered as carrying on activities 
within the meaning of section 4940 during such period. Such organization 
will therefore not be subject to the tax imposed under section 4940(a) 
for such period.
    (ii) The period referred to in subdivision (i) of this subparagraph 
is the 12-month period beginning with the first day of the 
organization's first taxable year which begins after December 31, 1969, 
but such period shall not be treated as ending before February 20, 1973.

[[Page 76]]

In the case of a private foundation distributing assets pursuant to 
section 507(b)(1)(A) to a medical research organization or a community 
trust (or in the case of a private foundation seeking to terminate into 
such an organization or trust pursuant to section 507(b)(1)(B)), the 
period described in this subdivision shall not be treated as ending 
before:
    (A) In the case of a distribution to a medical research 
organization, March 29, 1976; or
    (B) In the case of a community trust, May 11, 1977.
    (iii) If the period described in subdivision (ii) of this 
subparagraph has not expired prior to the due date for the 
organization's annual return required to be filed by section 6033 or 
6012 (determined with regard to any extension of time for filing the 
return) for its first taxable year which begins after December 31, 1969 
(or for any other taxable year ending before the expiration of the 
period referred to in subdivision (ii) of this subparagraph), and if the 
organization has not terminated its private foundation status under 
section 507(b)(1)(A) by such date, then notwithstanding the provisions 
of subdivision (ii) of this subparagraph, the organization must take 
either of the following courses of action:
    (A) Complete and file its annual return, including the line relating 
to excise taxes on investment income, by such date, and pay the tax on 
investment income imposed under section 4940 at the time it files its 
annual return. If such organization subsequently terminates its private 
foundation status under section 507(b)(1)(A) within the period specified 
in subdivision (ii) of this subparagraph, it may file a claim for refund 
of the tax paid under section 4940; or
    (B) Complete and file its annual return, except for the line 
relating to excise taxes on investment income, by such date, and, in 
lieu of paying the tax on investment income imposed under section 4940, 
file a statement with its annual return which establishes that the 
organization has taken affirmative action by such date to terminate its 
private foundation status under section 507(b)(1)(A). Such statement 
must indicate the type of affirmative action taken and explain how such 
action will result in the termination of its private foundation status 
under section 507(b)(1)(A). Such affirmative action may include making 
application to the appropriate State court for approval of the 
distribution of all net assets pursuant to section 507(b)(1)(A) in the 
case of a charitable trust, or the passage of a resolution by the 
organization's governing body directing the distribution of all net 
assets pursuant to section 507(b)(1)(A) in the case of a not-for-profit 
corporation. A written commitment or letter of agreement by the trustee 
or governing body to one or more section 509(a)(1) distributees 
indicating an intent to distribute all of the organization's net assets 
to such distributees will also constitute appropriate affirmative action 
for purposes of this subdivision. An organization may take such 
affirmative action and may terminate its private foundation status under 
section 507(b)(1)(A) in reliance upon 26 CFR 13.12 (rev. as of Jan. 1, 
1972) and upon the provisions of the notices of proposed rule making 
under sections 170(b)(1)(A), 507(b)(1), and 509. Thus, if a distributee 
organization meets the requirements of the provisions of the notices of 
proposed rule- making under sections 170(b)(1)(A), 507, or 509 as a 
distributee under section 507(b)(1)(A), the distributor organization may 
terminate its private foundation status under section 507(b)(1)(A) in 
reliance upon such provisions prior to the expiration of the period 
described in subdivision (ii) of this subparagraph. If such 
organization, however, fails to terminate its private foundation status 
under section 507(b)(1)(A) within the period specified in subdivision 
(ii) of this subparagraph by failing to meet the requirements of either 
the notices of proposed rulemaking under section 170(b)(1)(A), 
507(b)(1), or 509 or the final regulations published under these Code 
sections, the tax imposed under section 4940 shall be treated as if due 
from the due date for its annual return (determined without regard to 
any extension of time for filing its return).
    (6) Return required from organizations terminating private 
foundation status under section 507(b)(1)(A). (i) An organization which 
terminates its private

[[Page 77]]

foundation status under section 507(b)(1)(A) is required to file a 
return under the provisions of section 6043(b), rather than under the 
provisions of section 6050.
    (ii) An organization which terminates its private foundation status 
under section 507(b)(1)(A) is not required to comply with section 
6104(d) for the taxable year in which such termination occurs. For 
purposes of this subdivision, the term taxable year shall include the 
period described in subparagraph (5)(ii) of this paragraph.
    (7) Distribution of net assets. A private foundation will meet the 
requirement that it distribute all of its net assets within the meaning 
of section 507(b)(1)(A) only if it transfers all of its right, title, 
and interest in and to all of its net assets to one or more 
organizations referred to in section 507(b)(1)(A).
    (8) Effect of restrictions and conditions upon distributions of net 
assets--(i) In general. In order to effectuate a transfer of all of its 
right title and interest in and to all of its net assets within the 
meaning of paragraph (a)(7) of this section, a transferor private 
foundation may not impose any material restriction or condition that 
prevents the transferee organization referred to in section 507(b)(1)(A) 
(herein sometimes referred to as the public charity) from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes. Whether or not a 
particular condition or restriction imposed upon a transfer of assets is 
material (within the meaning of paragraph (a)(8) of this section) must 
be determined from all of the facts and circumstances of the transfer. 
Some of the more significant facts and circumstances to be considered in 
making such a determination are:
    (A) Whether the public charity (including a participating trustee, 
custodian, or agent in the case of a community trust) is the owner in 
fee of the assets it receives from the private foundation;
    (B) Whether such assets are to be held and administered by the 
public charity in a manner consistent with one or more of its exempt 
purposes;
    (C) Whether the governing body of the public charity has the 
ultimate authority and control over such assets, and the income derived 
therefrom; and
    (D) Whether, and to what extent, the governing body of the public 
charity is organized and operated so as to be independent from the 
transferor.
    (ii) Independent governing body. As provided in paragraph 
(a)(8)(i)(D) of this section, one of the more significant facts and 
circumstances to be considered in making the determination whether a 
particular condition or restriction imposed upon a transfer of assets is 
material within the meaning of paragraph (a)(8) of this section is 
whether, and the extent to which, the governing body is organized and 
operated so as to be independent from the transferor. In turn, the 
determination as to such factor must be determined from all of the facts 
and circumstances. Some of the more significant facts and circumstances 
to be considered in making such a determination are:
    (A) Whether, and to what extent, members of the governing body are 
comprised of persons selected by the transferor private foundation or 
disqualified persons with respect thereto, or are themselves such 
disqualified persons;
    (B) Whether, and to what extent, members of the governing body are 
selected by public officials acting in their capacities as such; and
    (C) How long a period of time each member of the governing body may 
serve as such. In the case of a transfer that is a community trust, the 
community trust shall meet paragraph (a)(8)(ii)(C) of this section if it 
meets the requirements of Sec. 1.170A-9(e)(13)(iv) (other than Sec. 
1.170A-9(e)(13)(iv) (C) or (D)), relating to rules for governing body.
    (iii) Factors not adversely affecting determination. The presence of 
some or all of the following factors will not be considered as 
preventing the transferee from freely and effectively employing the 
transferred assets, or the income derived therefrom, in furtherance of 
its exempt purposes (within the meaning of paragraph (a)(8)(i) of this 
section):
    (A) Name. The fund is given a name or other designation which is the 
same as or similar to that of the transferor

[[Page 78]]

private foundation or otherwise memorializes the creator of the 
foundation or his family.
    (B) Purpose. The income and assets of the fund are to be used for a 
designated purpose or for one or more particular section 509(a) (1), 
(2), or (3) organizations, and such use is consistent with the 
charitable, educational, or other basis for the exempt status of the 
public charity under section 501(c)(3).
    (C) Administration. The transferred assets are administered in an 
identifiable or separate fund, some or all of the principal of which is 
not to be distributed for a specified period, if the public charity 
(including a participating trustee, custodian, or agent in the case of a 
community trust) is the legal and equitable owner of the fund and the 
governing body exercises ultimate and direct authority and control over 
such fund, as, for example, a fund to endow a chair at a university or a 
medical research fund at a hospital. In the case of a community trust, 
the transferred assets must be administered in or as a component part of 
the community trust within the meaning of Sec. 1.170A-9(e)(11).
    (D) Restrictions on disposition. The transferor private foundation 
transfers property the continued retention of which by the transferee is 
required by the transferor if such retention is important to the 
achievement of charitable or other similar purposes in the community 
because of the peculiar features of such property, as, for example, 
where a private foundation transfers a woodland preserve which is to be 
maintained by the public charity as an arboretum for the benefit of the 
community. Such a restriction does not include a restriction on the 
disposition of an investment asset or the distribution of income.
    (iv) Adverse factors. The presence of any of the following factors 
will be considered as preventing the transferee from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes (within the meaning of 
paragraph (a)(8)(i) of this section):
    (A) Distributions. (1) With respect to distributions made after 
April 19, 1977, the transferor private foundation, a disqualified person 
with respect thereto, or any person or committee designated by, or 
pursuant to the terms of an agreement with, such a person (hereinafter 
referred to as donor), reserves the right, directly or indirectly, to 
name (other than by designation in the instrument of transfer of 
particular section 509(a) (1), (2), or (3) organizations) the persons to 
which the transferee public charity must distribute, or to direct the 
timing of such distributions (other than by direction in the instrument 
of transfer that some or all of the principal, as opposed to specific 
assets, not be distributed for a specified period) as, for example, by a 
power of appointment. The Internal Revenue Service will examine 
carefully whether the seeking of advice by the transferee from, or the 
giving of advice by, any donor after the assets have been transferred to 
the transferee constitutes an indirect reservation of a right to direct 
such distributions. In any such case, the reservation of such a right 
will be considered to exist where the only criterion considered by the 
public charity in making a distribution of income or principal from a 
donor's fund is advice offered by the donor. Whether there is a 
reservation of such a right will be determined from all of the facts and 
circumstances, including, but not limited to, the facts contained in 
paragraph (a)(8)(iv)(A) (2) and (3) of this section.
    (2) The presence of some or all of the following factors will 
indicate that the reservation of such a right does not exist:
    (i) There has been an independent investigation by the staff of the 
public charity evaluating whether the donor's advice is consistent with 
specific charitable needs most deserving of support by the public 
charity (as determined by the public charity);
    (ii) The public charity has promulgated guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity and the donor's advice is consistent with such 
guidelines;
    (iii) The public charity has instituted an educational program 
publicizing to donors and other persons the guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity;

[[Page 79]]

    (iv) The public charity distributes funds in excess of amounts 
distributed from the donor's fund to the same or similar types of 
organizations or charitable needs as those recommended by the donor; and
    (v) The public charity's solicitations (written or oral) for funds 
specifically state that such public charity will not be bound by advice 
offered by the donor.
    (3) The presence of some or all of the following factors will 
indicate the reservation of such a right does exist:
    (i) The solicitations (written or oral) of funds by the public 
charity state or imply, or a pattern of conduct on the part of the 
public charity creates an expectation, that the donor's advice will be 
followed;
    (ii) The advice of a donor (whether or not restricted to a 
distribution of income or principal from the donor's trust or fund) is 
limited to distributions of amounts from the donor's fund, and the 
factors described in paragraph (a)(8)(iv)(A)(2) or (i) or (ii) of this 
section are not present;
    (iii) Only the advice of the donor as to distributions of such 
donor's fund is solicited by the public charity and no procedure is 
provided for considering advice from persons other than the donor with 
respect to such fund; and
    (iv) For the taxable year and all prior taxable years the public 
charity follows the advice of all donors with respect to their funds 
substantially all of the time.
    (B) Other action or withholding of action. The terms of the transfer 
agreement, or any expressed or implied understanding, required the 
public charity to take or withhold action with respect to the 
transferred assets which is not designed to further one or more of the 
exempt purposes of the public charity, and such action or withholding of 
action would, if performed by the transferor private foundation with 
respect to such assets, have subjected the transferor to tax under 
chapter 42 (other than with respect to the minimum investment return 
requirement of section 4942(e)).
    (C) Assumption of leases, etc. The public charity assumes leases, 
contractural obligations, or liabilities of the transferor private 
foundation, or takes the assets thereof subject to such liabilities 
(including obligations under commitments or pledges to donees of the 
transferor private foundation), for purposes inconsistent with the 
purposes or best interests of the public charity, other than the payment 
of the transferor's chapter 42 taxes incurred prior to the transfer to 
the public charity to the extent of the value of the assets transferred.
    (D) Retention of investment assets. The transferee public charity is 
required by any restriction or agreement (other than a restriction or 
agreement imposed or required by law or regulatory authority), express 
or implied, to retain any securities or other investment assets 
transferred to it by the private foundation. In a case where such 
transferred assets consistently produce a low annual return of income, 
the Internal Revenue Service will examine carefully whether the 
transferee is required by any such restriction or agreement to retain 
such assets.
    (E) Right of first refusal. An agreement is entered into in 
connection with the transfer of securities or other property which 
grants directly or indirectly to the transferor private foundation or 
any disqualified person with respect thereto a right of first refusal 
with respect to the transferred securities or other property when and if 
disposed of by the public charity, unless such securities or other 
property was acquired by the transferor private foundation subject to 
such right of first refusal prior to October 9, 1969.
    (F) Relationships. An agreement is entered into between the 
transferor private foundation and the transferee public charity which 
establishes irrevocable relationships with respect to the maintenance or 
management of assets transferred to the public charity, such as 
continuing relationships with banks, brokerage firms, investment 
counselors, or other advisors with regard to the investments or other 
property transferred to the public charity (other than a relationship 
with a trustee, custodian, or agent for a community trust

[[Page 80]]

acting as such). The transfer of property to a public charity subject to 
contractual obligations which were established prior to November 11, 
1976 between the transferor private foundation and persons other than 
disqualified persons with respect to such foundation will not be treated 
as prohibited under the preceding sentence, but only if such contractual 
obligations were not entered into pursuant to a plan to terminate the 
private foundation status of the transferor under section 507(b)(1)(A) 
and if the continuation of such contractual obligations is in the best 
interests of the public charity.
    (G) Other conditions. Any other condition is imposed on action by 
the public charity which prevents it from exercising ultimate control 
over the assets received from the transferor private foundation for 
purposes consistent with its exempt purposes.
    (v) Examples. The provisions of paragraph (a)(8) of this sectiom may 
be illustrated by the following examples:

    Example 1. The M Private Foundation transferred all of its net 
assets to the V Cancer Institute, a public charity described in section 
170(b)(1)(A)(iii). Prior to the transfer, M's activities consisted of 
making grants to hospitals and universities to further research into the 
causes of cancer. Under the terms of the transfer, V is required to keep 
M's assets in a separate fund and use the income and principal to 
further cancer research. Although the assets may be used only for a 
limited purpose, this purpose is consistent with and in furtherance of 
V's exempt purposes, and does not prevent the transfer from being a 
distribution for purposes of section 507(b)(1)(A).
    Example 2. The N Private Foundation transferred all of its net 
assets to W University, a public charity described in section 
170(b)(1)(A)(ii). Under the terms of the transfer, W is required to use 
the income and principal to endow a chair at the university to be known 
as the ``John J. Doe Memorial Professorship'', named after N's creator. 
Although the transferred assets are to be used for a specified purpose 
by W, this purpose is in furtherance of W's exempt educational purposes, 
and there are no conditions on investment or reinvestment of the 
principal or income. The use of the name of the foundation's creator for 
the chair is not a restriction which would prevent the transfer from 
being a distribution for purposes of section 507(b)(1)(A).
    Example 3. The O Private Foundation transferred all of its net 
assets to X Bank as trustee for the P Community Trust, a community trust 
which is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, X is to hold the assets in trust for P and is 
directed to distribute the income annually to the Y Church, a public 
charity described in Section 170(b)(1)(A)(i). The distribution of income 
to Y Church is consistent with P's exempt purposes. If the trust created 
by this transfer otherwise meets the requirements of Sec. 1.170A-
9(e)(11) as a component part of P Community Trust, and assets 
transferred by O to X will be treated as distributed to one or more 
public charities within the meaning of section 507(b)(1)(A). The 
direction to distribute the income to Y Church meets the conditions of 
paragraph (a)(8)(iii)(B) of this section and will therefore not 
disqualify the transfer under section 507(b)(1)(A).
    Example 4. The U Private Foundation transferred all of its net 
assets to Z Bank as trustee for the R Community Trust, a community trust 
which is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, Z is to hold the assets in trust for R and 
distribute the income to those public charities described in section 
170(b)(1)(A) (i) through (vi) that are designated by B, the creator of 
U. R's governing body has no authority during B's lifetime to vary B's 
direction. Under the terms of the transfer, it is intended that Z retain 
the transferred assets in their present form for a period of 20 years, 
or until the date of B's death if it occurs before the expiration of 
such period. Upon the death of B, R will have the power to distribute 
the income to such public charities as it selects and may dispose of the 
corpus as it sees fit.
    Under paragraph (a)(8)(iv) (A) or (D) of this section, as a result 
of the restrictions imposed with respect to the transferred assets, 
there has been no distribution of all U's net assets within the meaning 
of section 507(b)(1)(A) at the time of the transfer. In addition, U has 
not transferred its net assets to a component part of R Community Trust, 
but rather to a separate trust described in Sec. 1.170A-9(e)(14).

    (vi) Transitional rule. If the governing instrument of the public 
charity (or an instrument of transfer) lacks the factors described in 
paragraph (a)(8)(i)(D) or (ii) of this section, but with respect to 
gifts or bequests acquired before January 1, 1982, the public charity 
changes its governing instrument (or instrument of transfer) by the 
later of November 11, 1977, or one year after the gift or bequest is 
acquired, in order to conform such instrument to such provisions, then 
such an instrument shall be treated as consistent with such provisions 
for taxable years beginning

[[Page 81]]

prior to the date of change. In addition, if prior to the later of such 
dates, the organization has instituted court proceedings in order to 
conform such an instrument, then it may apply (prior to the later of 
such dates) for an extension of the period to conform such instrument to 
such provisions. Such application shall be made to the Commissioner of 
Internal Revenue, Attention E:EO, Washington, DC 20224. The 
Commissioner, at the Commissioner's discretion, may grant such an 
extension, if in the Commissioner's opinion such a change will conform 
the instrument to such provisions, and the change will be made within a 
reasonable time.
    (b) Operation as a public charity--(1) In general. Under section 
507(b)(1)(B) an organization can terminate its private foundation status 
if the organization:
    (i) Meets the requirements of section 509(a) (1), (2), or (3) by the 
end of the 12-month period (as extended by paragraph (c)(3)(i) of this 
section) beginning with its first taxable year which begins after 
December 31, 1969, or for a continuous period of 60 calendar months 
beginning with the first day of any taxable year which begins after 
December 31, 1969;
    (ii) In compliance with section 507(b)(1)(B)(ii) and subparagraph 
(3) of this paragraph, properly notifies the district director before 
the commencement of such 12-month or 60-month period or before March 29, 
1973 that it is terminating its private foundation status; and
    (iii) Properly establishes immediately after the expiration of such 
12-month or 60-month period that such organization has complied with the 
requirements of section 509(a) (1), (2), or (3) by the end of the 12-
month period or during the 60-month period, as the case may be, in the 
manner described in subparagraph (4) of this paragraph.
    (2) Relationship of section 507(b)(1)(B) to section 507 (a), (c), 
and (g). Since section 507(a) does not apply to a termination described 
in section 507(b)(1)(B), a private foundation's notification that it is 
commencing a termination pursuant to section 507(b)(1)(B) will not be 
treated as a notification described in section 507(a) even if the 
private foundation does not successfully terminate its private 
foundation status pursuant to section 507(b)(1)(B). A private foundation 
which terminates its private foundation status under section 
507(b)(1)(B) does not incur tax under section 507(c) and, therefore, no 
abatement of such tax under section 507(g) is required.
    (3) Notification of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(ii), an organization shall 
before the commencement of the 12-month or 60-month period under section 
507(b)(1)(B)(i) (or before March 29, 1973) or, in the case of the 12-
month period for a community trust, before May 11, 1977, notify the 
district director of its intention to terminate its private foundation 
status.

Such notification shall contain the following information:
    (i) The name and address of the private foundation;
    (ii) Its intention to terminate its private foundation status;
    (iii) Whether the 12-month or 60-month period shall apply;
    (iv) The Code section under which it seeks classification (section 
509(a) (1), (2), or (3));
    (v) If section 509(a)(1) is applicable, the clause of section 
170(b)(1)(A) involved;
    (vi) The date its regular taxable year begins; and
    (vii) The date of commencement of the 12-month or 60-month period.
    (4) Establishment of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(iii), an organization shall 
within 90 days after the expiration of the 12-month or 60-month period, 
file such information with the district director as is necessary to make 
a determination as to the organization's status as an organization 
described under section 509(a) (1), (2), or (3) and the regulations 
thereunder. See paragraphs (c) and (d) of this section as to the 
information required to be submitted under this subparagraph.
    (5) Incomplete information; 12- and 60-month terminations. The 
failure to supply, within the required time, all of the information 
required by subparagraph (3) or (4) of this paragraph is not alone 
sufficient to constitute a failure to satisfy the requirements of 
section 507(b)(1)(B). If the information which is submitted within the 
required time is

[[Page 82]]

incomplete and the organization supplies the necessary additional 
information at the request of the Commissioner within the additional 
time period allowed by him, the original submission will be considered 
timely.
    (6) Application of special rules and filing requirements. An 
organization which has terminated its private foundation status under 
section 507(b)(1)(B) is not required to comply with the special rules 
set forth in section 508 (a) and (b). Such organization is also not 
required to file a return under the provisions of section 6043(b) or 
6050 by reason of termination of its private foundation status under the 
provisions of section 507(b)(1)(B).
    (7) Extension of time to assess deficiencies. If a private 
foundation files a notification (described in subparagraph (3) of this 
paragraph) that it intends to begin a 60-month termination pursuant to 
section 507(b)(1)(B) and does not file a request for an advance ruling 
pursuant to paragraph (e) of this section, such private foundation may 
file with the notification described in subparagraph (3) of this 
paragraph a consent under section 6501(c)(4) to the effect that the 
period of limitation upon assessment under section 4940 for any taxable 
year within the 60-month termination period shall not expire prior to 1 
year after the date of the expiration of the time prescribed by law for 
the assessment of a deficiency for the last taxable year within the 60-
month period. Such consents, if filed, will ordinarily be accepted by 
the Commissioner. See paragraph (f)(3) of this section for an 
illustration of the procedure required to obtain a refund of the tax 
imposed by section 4940 in a case where such a consent is not in effect.
    c) Twelve-month terminations--(1) Method of determining normal 
sources of support--(i) In general. The 12-month termination provisions 
of section 507(b)(1)(B) permit a private foundation to terminate its 
private foundation status by changing its organizational structure, its 
operations, the sources of its support, or any combination thereof, in 
order to conform to the requirements of section 509(a) (1), (2), or (3) 
by the end of the 12-month period.
    (ii) Support requirements for 12-month termination under section 
170(b)(1) (A)(vi). A private foundation attempting to meet the 
requirements of section 509(a)(1) as an organization described in 
section 170(b)(1)(A)(vi) will be considered normally to receive a 
substantial part of its support from governmental units or direct or 
indirect contributions from the general public if it can establish that 
it has changed the sources of its support before the close of the 12-
month period to those of an organization described in section 
170(b)(1)(A)(vi) and it can reasonably be expected to maintain its 
publicly supported status for subsequent years. In order to establish 
these facts, an organization shall submit all information sufficient to 
make a determination under Sec. 1.170A-9(e) as if such provisions 
applied, including a description of all organizational and operational 
changes which have occurred during the 12-month period. It shall also 
submit detailed information with respect to its sources of support for 
the 12-month period, as well as for the four taxable years immediately 
preceding the 12-month period. In applying the tests contained in Sec. 
1.170A-9(e), however, data from periods preceding the 12-month period 
shall be disregarded except for purposes of determining whether the 
organization has effectively changed its sources of support and whether 
it can reasonably be expected to maintain such publicly supported status 
for subsequent years. Thus, for example, in applying the mathematical 
tests of Sec. 1.170A-9(e) only data for the 12-month period may enter 
into the computation.
    (iii) Support requirements for 12-month terminations under section 
170(b)(1)(A)(iv). Section 170(b)(1) (A)(iv) describes an organization 
which normally receives a substantial part of its support (exclusive of 
income from related activities) from the United States or any State or 
political subdivision thereof, or from the general public, and which is 
organized and operated exclusively to receive, hold, invest, and 
administer property and to make expenditures to or for the benefit of 
certain colleges or universities. For purposes of the 12-month 
termination period, the rule set forth in subdivision (ii) of this 
subparagraph with respect to section 170(b)(1)(A)(vi) organizations

[[Page 83]]

shall be applicable in determining whether an organization normally 
receives a substantial part of its support from the sources required 
under section 170(b)(1)(A)(iv).
    (iv) Support requirements for 12-month terminations under section 
509(a)(2). An organization attempting to terminate its private 
foundation status under section 507(b)(1)(B) by meeting the requirements 
of section 509(a)(2) by the end of the 12-month period will be 
considered as normally receiving its support in compliance with the one-
third support requirements of section 509(a)(2) if:
    (A) For the 12-month period under section 507(b)(1)(B), the 
organization receives more than one-third of its support from gifts, 
grants, contributions, membership fees, and gross receipts from related 
activities (as limited by section 509(a)(2)(A)(ii)) and not more than 
one-third of its support from items described in section 509 (a)(2)(B), 
and
    (B) The organization can establish that it can reasonably be 
expected to maintain its continued public support for subsequent years. 
In order to establish a reasonable expectation of continued public 
support, an organization shall submit a detailed statement describing 
its past and current operations, any organizational or operational 
changes and when such changes have occurred, and any changes in its 
foundation managers (as defined in section 4946(b)(1)). Duplicate copies 
of its governing instrument and bylaws, with an indication of any 
amendments made, and detailed information with respect to its sources of 
support for the 4 taxable years immediately preceding the 12-month 
period shall also be submitted as part of the evidence that the 
organization can reasonably be expected to maintain its publicly 
supported status.
    (2) Organizational and operational tests--(i) Section 509(a)(3) 
organizations--(A) In general. An organization attempting to terminate 
its private foundation status under section 507(b)(1)(B) by meeting the 
requirements of section 509(a)(3) by the end of the 12-month period is 
required to meet the organizational and operational test of section 
509(a)(3)(A), in addition to the requirements of section 509(a)(3) (B) 
and (C), by the end of the 12-month period beginning with its first 
taxable year which begins after December 31, 1969. An organization may 
qualify under section 509(a)(3)(A) even though its original governing 
instrument did not limit its purposes to those set forth in section 
509(a)(3)(A) and even though it operated for some other purpose before 
the end of the 12-month period, if it has amended its governing 
instrument and changed its operations to conform to the requirements of 
section 509(a)(3) by the end of the 12-month period.
    (B) Proof of changed status. In order to establish that an 
organization described in (A) of this subdivision will continue to be 
operated exclusively for the required purposes in years subsequent to 
the end of the 12-month period, such organization shall submit a 
detailed statement describing its past and current operations, any 
organizational or operational changes and when such changes have 
occurred, any changes in foundation managers (as defined in section 
4946(b)(1)), and duplicate copies of its governing instrument and 
bylaws, with an indication of any amendments made. A detailed statement 
of the relationship between such organization and the specified 
organizations described in section 509(a) (1) or (2) (as required by 
section 509(a)(3) (A) and (B)) and all pertinent information to 
establish that the organization does not violate the control 
requirements of section 509(a)(3)(C) shall also be submitted.
    (ii) Section 509(a)(1) organizations other than those described in 
section 170(b)(1)(A)(vi)--
    (A) In general. An organization attempting to terminate its private 
foundation status under section 507(b)(1)(B) by meeting the requirements 
of section 170(b)(1)(A) (i), (ii), (iii), (iv), or (v) by the end of the 
12-month period is required to be operated as an organization described 
in clauses (i), (ii), (iii), (iv), or (v) of section 170(b)(1)(A) by the 
end of the 12-month period beginning with its first taxable year which 
begins after December 31, 1969.
    (B) Proof of changed status. In order to establish that it will 
continue to be operated as an organization described in section 
509(a)(1) in years subsequent to

[[Page 84]]

the end of the 12-month period, the organization shall submit a detailed 
statement describing its past and current operations, any organizational 
or operational changes and when such changes have occurred, and any 
changes in its foundation managers (as defined in section 4946(b)(1)). 
Duplicate copies of its governing instrument and bylaws, with an 
indication of any amendments made, and its financial statements for the 
4-taxable years immediately preceding the 12-month period shall also be 
submitted as evidence that the organization can reasonably be expected 
to maintain its status as an organization described in section 
170(b)(1)(A)(i), (ii), (iii), (iv), or (v).
    (3) Extensions of the 12-month period. (i) For purposes of this 
section, an organization may accomplish a 12-month termination if it 
meets the requirements of section 507(b)(1)(B) and this paragraph for 
such a termination with respect to any of the following periods:
    (A) The 12-month period beginning with the organization's first 
taxable year which begins after December 31, 1969;
    (B) The period described in paragraph (a)(5)(ii) of this section; or
    (C) Any period consisting of two or more taxable years beginning 
with the organization's first taxable year beginning after December 31, 
1969, and ending with any taxable year ending before the end of the 
period described in paragraph (a)(5)(ii) of this section.
    (ii) An organization will be considered as ``normally'' meeting the 
requirements of section 170(b)(1)(A) (iv) or (vi) or 509(a)(2), as the 
case may be, if it meets the requirements of such provision with respect 
to any period described in subdivision (i) (A), (B), or (C) of this 
subparagraph. Thus, for example, an organization on a calendar year 
basis which seeks to convert to a section 509(a)(2) organization under 
section 507(b)(1)(B) may meet the one-third support requirement based on 
the aggregate support received during a period described in subdivision 
(i) (A), (B), or (C) of this subparagraph, for purposes of subparagraph 
(1)(iv) of this paragraph.
    (4) Status of organization subsequent to the 12-month period. For 
purposes of sections 507 through 509, an organization, the status of 
which as a private foundation is terminated under section 507(b)(1), 
shall (except as provided in paragraph (b)(6) of this section) be 
treated as an organization created on the day after the date of such 
termination. However, termination of private foundation status under the 
provisions of section 507(b)(1)(B) is based upon an organization's 
submission of information establishing compliance by the end of the 12-
month period with the requirements of subparagraph (1) or (2) of this 
paragraph. Therefore, if in the 4 taxable years immediately following 
the end of the 12-month period, the sources of support or the methods of 
operation of the organization are materially different from the facts 
and circumstances presented during the 12-month period upon which the 
determination under section 507(b)(1)(B)(iii) was made (and such 
material difference adversely affects such determination), the 
organization will be deemed not to have satisfied the requirements of 
section 507(b)(1)(B). Under such circumstances, section 509(c) will not 
apply and the organization will continue to remain subject to the 
provisions of section 507. However, the status of grants and 
contributions under sections 170, 4942, and 4945 will not be affected 
until the Internal Revenue Service makes notice to the public (such as 
by publication in the Internal Revenue Bulletin) that the organization 
has been deleted from classification as an organization described in 
section 509(a) (1), (2), or (3) unless the donor (1) was in part 
responsible for, or was aware of, the act or failure to act that 
resulted in the organization's inability to satisfy the requirements of 
section 507(b) (1)(B), or (2) had knowledge that such organization would 
be deleted from classification as an organization described in section 
509(a) (1), (2), or (3). Prior to the making of any grant or 
contribution which allegedly will not result in the grantee's loss of 
classification under section 509(a) (1), (2), or (3), a potential 
grantee organization may request a ruling whether such grant or 
contribution may be made without such loss of classification. A request 
for such ruling may be filed by

[[Page 85]]

the grantee organization with the district director. The issuance of 
such ruling will be at the sole discretion of the Commissioner.
    (d) Sixty-month terminations--(1) Method of determining normal 
sources of support. (i) In order to meet the requirement of section 
507(b)(1)(B) for the 60-month termination period as a section 509(a) (1) 
or (2) organization, an organization must meet the requirements of 
section 509(a) (1) or (2), as the case may be, for a continuous period 
of at least 60 calendar months. In determining whether an organization 
seeking status under section 509(a)(1) as an organization described in 
section 170(b)(1)(A) (iv) or (vi) or under section 509(a)(2) 
``normally'' meets the requirements set forth under such sections, 
support received in taxable years prior to the commencement of the 60-
month period shall not be taken into consideration, except as otherwise 
provided in this section. Therefore, in such cases rules similar to the 
rules applicable to new organizations would apply.
    (ii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(1) organization described in section 
170(b)(1)(A)(vi) for a continuous period of 60 calendar months only if 
the organization satisfies the provisions of Sec. 1.170A-9(e) based 
upon aggregate data for such entire period, rather than for any shorter 
period set forth in Sec. 1.170A-9(e). Except for the substitution of 
such 60-month period for the periods described in Sec. 1.170A-9(e), all 
other provisions of such regulations pertinent to determining an 
organization's normal sources of support shall remain applicable.
    (iii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(2) organization only if such 
organization meets the support requirements set forth in section 
509(a)(2) (A) and (B) for the continuous period of 60 calendar months 
prescribed under section 507(b)(1)(B), rather than for any shorter 
period set forth in the regulations under section 509(a)(2). Except for 
the substitution of such 60-month period for the periods described in 
the regulations under section 509(a)(2), all other provisions of such 
regulations pertinent to determining an organization's normal sources of 
support shall remain applicable.
    (2) Organizational and operational tests. In order to meet the 
requirements of section 507(b)(1)(B) for the 60-month termination period 
as an organization described in section 170(b)(1)(A) (i), (ii), (iii), 
(iv), or (v) or section 509(a)(3), as the case may be, an organization 
must meet the requirements of the applicable provision for a continuous 
period of at least 60 calendar months. For purposes of section 
507(b)(1)(B), an organization will be considered to be such an 
organization only if it satisfies the requirements of the applicable 
provision (including with respect to section 509(a)(3), the 
organizational and operational test set forth in subparagraph (A) 
thereof) at the commencement of such 60-month period and continuously 
thereafter during such period.
    (e) Advance rulings for 60-month terminations--(1) In general. An 
organization which files the notification required by section 
507(b)(1)(B)(ii) that it is commencing a 60-month termination may obtain 
an advance ruling from the Commissioner that it can be expected to 
satisfy the requirements of section 507(b)(1)(B)(i) during the 60-month 
period. Such an advance ruling may be issued if the organization can 
reasonably be expected to meet the requirements of section 
507(b)(1)(B)(i) during the 60-month period. The issuance of a ruling 
will be discretionary with the Commissioner.
    (2) Basic consideration. In determining whether an organization can 
reasonably be expected (within the meaning of subparagraph (1) of this 
paragraph) to meet the requirements of section 507(b)(1)(B)(i) for the 
60-month period, the basic consideration is whether its organizational 
structure (taking into account any revisions made prior to the beginning 
of the 60-month period), proposed programs or activities, intended 
method of operation, and projected sources of support are such as to 
indicate that the organization is likely to satisfy the requirements of 
section 509(a) (1), (2), or (3) and paragraph (d) of this section during 
the 60-month period. In making such a determination, all pertinent facts 
and circumstances shall be considered.

[[Page 86]]

    (3) Reliance by grantors and contributors. For purposes of sections 
170, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 
2522, grants or contributions to an organization which has obtained a 
ruling referred to in this paragraph will be treated as made to an 
organization described in section 509(a) (1), (2), or (3), as the case 
may be, until notice that such advance ruling is being revoked 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 aware of, the act or failure to act 
that resulted in the organization's failure to meet the requirements of 
section 509(a) (1), (2), or (3), or acquired knowledge that the Internal 
Revenue Service had given notice to such organization that its advance 
ruling would be revoked. Prior to the making of any grant or 
contribution which allegedly will not result in the grantee's failure to 
meet the requirements of section 509(a) (1), (2), or (3), a potential 
grantee organization may request a ruling whether such grant or 
contribution may be made without such failure. A request for such ruling 
may be filed by the grantee organization with the district director. The 
issuance of such ruling will be at the sole discretion of the 
Commissioner. The organization must submit all information necessary to 
make a determination on the factors referred to in subparagraph (2) of 
this paragraph. If a favorable ruling is issued, such ruling may be 
relied upon by the grantor or contributor of the particular contribution 
in question for purposes of sections 170, 507, 545(b)(2), 556(b)(2), 
642(c), 4942, 4945, 2055, 2106(a)(2), and 2522.
    (4) Reliance by organization. An organization obtaining an advance 
ruling pursuant to this paragraph cannot rely on such a ruling. 
Consequently, if the organization does not pay the tax imposed by 
section 4940 for any taxable year or years during the 60-month period, 
and it is subsequently determined that such tax is due for such year or 
years (because the organization did not in fact complete a successful 
termination pursuant to section 507(b)(1)(B) and was not treated as an 
organization described in section 509(a) (1), (2), or (3) for such year 
or years), the organization is liable for interest in accordance with 
section 6601 if any amount of tax under section 4940 has not been paid 
on or before the last date prescribed for payment. However, since any 
failure to pay such tax during the 60-month period (or prior to the 
revocation of such ruling) is due to reasonable cause, the penalty under 
section 6651 with respect to the tax imposed by section 4940 shall not 
apply.
    (5) Extension of time to assess deficiencies. The advance ruling 
described in subparagraph (1) of this paragraph shall be issued only if 
such organization's request for an advance ruling is filed with a 
consent under section 6501(c)(4) to the effect that the period of 
limitation upon assessment under section 4940 for any taxable year 
within the advance ruling period shall not expire prior to 1 year after 
the date of the expiration of the time prescribed by law for the 
assessment of a deficiency for the last taxable year within the 60-month 
period.
    (f) Effect on grantors or contributors and on the organization 
itself--(1) Effect of satisfaction of requirements for termination--(i) 
Treatment during the termination period. In the event that an 
organization satisfies the requirements of section 507(b)(1)(B) for 
termination of its private foundation status by the end of the 12-month 
period or during the continuous 60-month period, such organization shall 
be treated for such entire 12-month or 60-month period in the same 
manner as an organization described in section 509(a) (1), (2), or (3).
    (ii) Twelve-month terminations by fiscal year organizations. In the 
case of an organization which operates on a fiscal year basis and 
terminates its private foundation status by the end of the 12-month 
period beginning with its first taxable year which begins after December 
31, 1969, such 12-month period shall, for purposes of this paragraph, be 
treated as including the period between January 1, 1970, and the last 
day of the taxable year immediately preceding its first taxable year 
which begins after December 31, 1969, so long as the requirements of 
section 507(b)(1)(B) and paragraph (c) of this section are met by the 
end of the 12-month period (including such additional period).

[[Page 87]]

    (2) Failure to meet termination requirements--(i) In general. Except 
as otherwise provided in subdivision (ii) of this subparagraph and 
paragraph (e) of this section, any organization which fails to satisfy 
the requirements of section 507(b)(1)(B) for termination of its private 
foundation status by the end of the 12-month period or during the 
continuous 60-month period shall be treated as a private foundation for 
the entire 12-month or 60-month period, for purposes of sections 507 
through 509 and chapter 42, and grants or contributions to such an 
organization shall be treated as made to a private foundation for 
purposes of sections 170, 507(b)(1)(A), 4942, and 4945.
    (ii) Certain 60-month terminations. Notwithstanding subdivision (i) 
of this subparagraph, if an organization fails to satisfy the 
requirements of section 509(a) (1), (2), or (3) for the continuous 60-
month period but does satisfy the requirements of section 509(a) (1), 
(2), or (3), as the case may be, for any taxable year or years during 
such 60-month period, the organization shall be treated as a section 
509(a) (1), (2), or (3) organization for such taxable year or years and 
grants or contributions made during such taxable year or years shall be 
treated as made to an organization described in section 509(a) (1), (2), 
or (3). In addition, sections 507 through 509 and chapter 42 shall not 
apply to such organization for any taxable year within such 60-month 
period for which it does meet such requirements. For purposes of 
determining whether an organization satisfies the requirements of 
section 509(a) (1), (2), or (3) for any taxable year in the 60-month 
period, the organization shall be treated as if it were a new 
organization with its first taxable year beginning on the date of the 
commencement of the 60-month period. Thus, for example, if an 
organization were attempting to terminate its private foundation status 
under section 507(b)(1)(B) by meeting the requirements of section 
170(b)(1)(A)(vi), the rules under Sec. 1.170A-9(e) relating to the 
initial determination of status of a new organization would apply.
    (iii) Aggregate tax benefit. For purposes of section 507(d), the 
organization's aggregate tax benefit resulting from the organization's 
section 501(c)(3) status shall continue to be computed from the date 
from which such computation would have been made, but for the notice 
filed under section 507(b)(1)(B)(ii), except that any taxable year 
within such 60-month period for which such organization meets the 
requirements of section 509(a) (1), (2), or (3) shall be excluded from 
such computations.
    (iv) Excess business holdings. See section 4943 and the regulations 
thereunder for rules relating to decreases in a private foundation's 
holdings in a business enterprise which are caused by the foundation's 
failure to terminate its private foundation status after giving the 
notification for termination under section 507(b)(1)(B)(ii).
    (3) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Y, a calendar year private foundation, notifies the 
district director that it intends to terminate its private foundation 
status by converting into a publicly supported organization described in 
section 170(b)(1)(A)(vi) and that its 60-month termination period will 
commence on January 1, 1974. Y does not obtain a ruling described in 
paragraph (e) of this section. Based upon its support for 1974 Y does 
not qualify as a publicly supported organization within the meaning of 
Sec. 1.170A-9(e) and this paragraph. Consequently, in order to avoid 
the risks of penalties and interest if Y fails to terminate within the 
60-month period, Y files its return as a private foundation and pays the 
tax imposed by section 4940. Similarly, based upon its support for the 
period 1974 through 1975, fails to qualify as such a publicly supported 
organization and files its return and pays the tax imposed by section 
4940 for both 1975 and 1976. Since a consent (described in paragraph 
(b)(7) of this section) which would prevent the period of limitation 
from expiring is not in effect, in order to be able to file a claim for 
refund, Y and the district director agree to extend the period of 
limitation for all taxes imposed under chapter 42. However, based upon 
its support for the period 1974 through 1976 Y does qualify as a 
publicly supported organization, and therefore shall not be treated as a 
private foundation for either 1977 or 1978 even if it fails to terminate 
within the 60-month period. However, based upon the aggregate data for 
the entire 60-month period (1974 through 1978), Y does qualify as an 
organization described in section 170(b)(1)(A)(vi). Consequently, 
pursuant to this paragraph, Y is treated as if it had been a publicly 
supported organization for the entire 60-month period. Y files claim for 
refund

[[Page 88]]

for the taxes paid under section 4940 for the years 1974, 1975, and 
1976, and such taxes are refunded.

    (g) Special transitional rules for organizations operating as public 
charities. Section 4940 imposes a tax upon private foundations with 
respect to the carrying on of activities for each taxable year. For 
purposes of section 4940, an organization which terminates its private 
foundation status under section 507(b)(1)(B) by the end of the period 
described in paragraph (a)(5)(ii) of this section will not be considered 
as carrying on activities within the meaning of section 4940 during such 
period. Such organization will therefore not be subject to the tax 
imposed under section 4940 for such period. Consequently, in the case of 
an organization seeking to terminate its private foundation status under 
section 507(b)(1)(B) if the period described in paragraph (a)(5)(ii) of 
this section has not expired prior to the due date for the 
organization's annual return required to be filed under section 6033 or 
6012 (determined with regard to any extension of time for filing the 
return) for its first taxable year which begins after December 31, 1969 
(or any other taxable year ending before the expiration of the period 
described in paragraph (a)(5)(ii) of this paragraph) and if the 
organization has not terminated its private foundation status under 
section 507(b)(1)(B) by such date, then notwithstanding the provisions 
of paragraph (f) of this section, the organization must take either of 
the following courses of action:
    (1) Complete and file its annual return including the line relating 
to excise taxes on investment income, by such date, and pay the tax on 
investment income imposed under section 4940 at the time it files its 
annual return. If such organization subsequently terminates its private 
foundation status under section 507(b)(1)(B) within a period specified 
in paragraph (c)(3)(i) of this section, it may file a claim for refund 
of the tax paid under section 4940; or
    (2) Complete and file its annual return, except for the line 
relating to excise taxes on investment income, by such date, and in lieu 
of paying the tax on investment income imposed under section 4940, file 
a statement with its annual return which establishes that the 
organization has taken affirmative action by such date to terminate its 
private foundation status under section 507(b)(1)(B). Such statement 
must indicate the type of affirmative action taken and explain how such 
action will result in the termination of its private foundation status 
under section 507(b)(1)(B). Such affirmative action may include making 
application to the appropriate State court for approval to amend the 
provisions of the organization's trust instrument to limit payments to 
specified section 509(a) (1) or (2) beneficiaries pursuant to section 
509(a)(3) in the case of a charitable trust; commencing a fund-raising 
drive among the general public in the case of an organization seeking to 
become a section 170(b)(1)(A)(vi) or 509(a)(2) organization; or the 
passage of a resolution by the organization's governing body or the 
filing of an amendment to the organization's articles of incorporation 
permitting a change in the operations of the organization to enable it 
to conform to the provisions of section 509(a) (1), (2), or (3) in the 
case of a not-for-profit corporation. An organization may take such 
affirmative action and may terminate its private foundation status under 
section 507(b)(1)(B) in reliance upon 26 CFR 13.12 (rev. as of Jan. 1, 
1972) and upon the provisions of the notices of proposed rulemaking 
under sections 170(b)(1)(A), 507(b)(1), and 509. Thus, if an 
organization meets the requirement of the provisions of the notice of 
proposed rulemaking as a section 509(a)(3) organization, such 
organization may terminate its private foundation status under section 
507(b)(1)(B) in reliance upon such provisions prior to the expiration of 
the period described in paragraph (a)(5)(ii) of this section. If such 
organization, however, fails to terminate its private foundation status 
under section 507(b)(1)(B) within the period specified in paragraph 
(a)(5)(ii) of this section by failing to meet the requirements of either 
the notices of proposed rulemaking under section 170(b)(1)(A), 
507(b)(1), or 509 or the final regulations published under these Code 
sections, the tax imposed under section 4940 shall be treated as if due 
from the due date for its annual return (determined without regard to

[[Page 89]]

any extension of time, for filing its return).
    (h) Effective/applicability date. This section shall apply to tax 
years beginning before January 1, 2008.

[T.D. 7248, 38 FR 861, Jan. 5, 1973; 38 FR 3598, Feb. 8, 1973; 38 FR 
4259, Feb. 12, 1973, as amended by T.D. 7290, 38 FR 31833, Nov. 19, 
1973; T.D. 7440, 41 FR 50654, Nov. 17, 1976; 41 FR 52454, Nov. 30, 1976; 
T.D. 7465, 42 FR 4437, Jan. 25, 1977; T.D. 7784, 46 FR 37889, July 23, 
1981; T.D. 9423, 73 FR 52544, Sept. 9, 2008]



Sec. 1.507-2T  Special rules; transfer to, or operation as, public charity 

(temporary).

    (a) Transfer to public charities--(1) General rule. Under section 
507(b)(1)(A) a private foundation, with respect to which there have not 
been either willful repeated acts (or failures to act) or a willful and 
flagrant act (or failure to act) giving rise to liability for tax under 
chapter 42, may terminate its private foundation status by distributing 
all of its net assets to one or more organizations described in section 
170(b)(1)(A) (other than in clauses (vii) and (viii)) each of which has 
been in existence and so described for a continuous period of at least 
60 calendar months immediately preceding such distribution. Because 
section 507(a) does not apply to such a termination, a private 
foundation which makes such a termination is not required to give the 
notification described in section 507(a)(1). A private foundation that 
terminates its private foundation status under section 507(b)(1)(A) does 
not incur tax under section 507(c) and, therefore, no abatement of such 
tax under section 507(g) is required.
    (2) Effect of current ruling. A private foundation seeking to 
terminate its private foundation status pursuant to section 507(b)(1)(A) 
may rely on a ruling or determination letter issued to a potential 
distributee organization that such distributee organization is an 
organization described in section 170(b)(1)(A)(i), (ii), (iii), (iv), 
(v) or (vi) in accordance with the provisions of Sec. 1.509(a)-7.
    (3) Organizations described in more than one clause of section 
170(b)(1)(A). For purposes of this paragraph and section 507(b)(1)(A), 
the parenthetical term ``other than in clauses (vii) and (viii)'' shall 
refer only to an organization that is described only in section 
170(b)(1)(A)(vii) or (viii). Thus, an organization described in section 
170(b)(1)(A)(i), (ii), (iii), (iv), (v), or (vi) will not be precluded 
from being a distributee described in section 507(b)(1)(A) merely 
because it also appears to meet the description of an organization 
described in section 170(b)(1)(A) (vii) or (viii).
    (4) Applicability of chapter 42 to foundations terminating under 
section 507(b)(1)(A). An organization that terminates its private 
foundation status pursuant to section 507(b)(1)(A) will remain subject 
to the provisions of chapter 42 until the distribution of all of its net 
assets to distributee organizations described in section 507(b)(1)(A) 
has been completed.
    (5) Return required from organizations terminating private 
foundation status under section 507(b)(1)(A).
    (i) An organization that terminates its private foundation status 
under section 507(b)(1)(A) is required to file a return under the 
provisions of section 6043(b), rather than under the provisions of 
section 6050.
    (ii) An organization that terminates its private foundation status 
under section 507(b)(1)(A) is not required to comply with section 
6104(d) for the taxable year in which such termination occurs.
    (6) Distribution of net assets. A private foundation will meet the 
requirement that it ``distribute all of its net assets'' within the 
meaning of section 507(b)(1)(A) only if it transfers all of its right, 
title, and interest in and to all of its net assets to one or more 
organizations referred to in section 507(b)(1)(A).
    (7) Effect of restrictions and conditions upon distributions of net 
assets--(i) In general. In order to effectuate a transfer of ``all of 
its right, title, and interest in and to all of its net assets'' within 
the meaning of paragraph (a)(6) of this section, a transferor private 
foundation may not impose any material restriction or condition that 
prevents the transferee organization referred to in section 507(b)(1)(A) 
(herein sometimes referred to as the ``public charity'') from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes. Whether

[[Page 90]]

or not a particular condition or restriction imposed upon a transfer of 
assets is material (within the meaning of this paragraph (a)(7)) must be 
determined from all of the facts and circumstances of the transfer. Some 
of the more significant facts and circumstances to be considered in 
making such a determination are--
    (A) Whether the public charity (including a participating trustee, 
custodian, or agent in the case of a community trust) is the owner in 
fee of the assets it receives from the private foundation;
    (B) Whether such assets are to be held and administered by the 
public charity in a manner consistent with one or more of its exempt 
purposes;
    (C) Whether the governing body of the public charity has the 
ultimate authority and control over such assets, and the income derived 
therefrom; and
    (D) Whether, and to what extent, the governing body of the public 
charity is organized and operated so as to be independent from the 
transferor.
    (ii) Independent governing body. As provided in paragraph 
(a)(7)(i)(D) of this section, one of the more significant facts and 
circumstances to be considered in making the determination whether a 
particular condition or restriction imposed upon a transfer of assets is 
material within the meaning of this paragraph (a)(7) is whether, and the 
extent to which, the governing body is organized and operated so as to 
be independent from the transferor. In turn, the determination as to 
such factor must be determined from all of the facts and circumstances. 
Some of the more significant facts and circumstances to be considered in 
making such a determination are--
    (A) Whether, and to what extent, members of the governing body are 
comprised of persons selected by the transferor private foundation or 
disqualified persons with respect thereto, or are themselves such 
disqualified persons;
    (B) Whether, and to what extent, members of the governing body are 
selected by public officials acting in their capacities as such; and
    (C) How long a period of time each member of the governing body may 
serve as such. In the case of a transfer that is to a community trust, 
the community trust shall meet this paragraph (a)(7)(ii)(C) if, with 
respect to terms of office beginning after the date of transfer:
    (1) its governing body is comprised of members who may serve a 
period of not more than ten consecutive years; and
    (2) Upon completion of a period of service (beginning before or 
after the date of transfer), no member may serve again within a period 
consisting of the lesser of 5 years or the number of consecutive years 
the member has immediately completed serving.
    (iii) Factors not adversely affecting determination. The presence of 
some or all of the following factors will not be considered as 
preventing the transferee ``from freely and effectively employing the 
transferred assets, or the income derived therefrom, in furtherance of 
its exempt purposes'' (within the meaning of paragraph (a)(7)(i) of this 
section):
    (A) Name. The fund is given a name or other designation which is the 
same as or similar to that of the transferor private foundation or 
otherwise memorializes the creator of the foundation or his family.
    (B) Purpose. The income and assets of the fund are to be used for a 
designated purpose or for one or more particular section 509(a)(1), (2), 
or (3) organizations, and such use is consistent with the charitable, 
educational, or other basis for the exempt status of the public charity 
under section 501(c)(3).
    (C) Administration. The transferred assets are administered in an 
identifiable or separate fund, some or all of the principal of which is 
not to be distributed for a specified period, if the public charity 
(including a participating trustee, custodian, or agent in the case of a 
community trust) is the legal and equitable owner of the fund and the 
governing body exercises ultimate and direct authority and control over 
such fund, as, for example, a fund to endow a chair at a university or a 
medical research fund at a hospital. In the case of a community trust, 
the transferred assets must be administered in or as a component part of 
the community trust within the meaning of Sec. 1.170A-9T(f)(11).
    (D) Restrictions on disposition. The transferor private foundation 
transfers

[[Page 91]]

property the continued retention of which by the transferee is required 
by the transferor if such retention is important to the achievement of 
charitable or other similar purposes in the community because of the 
peculiar features of such property, as, for example, where a private 
foundation transfers a woodland preserve which is to be maintained by 
the public charity as an arboretum for the benefit of the community. 
Such a restriction does not include a restriction on the disposition of 
an investment asset or the distribution of income.
    (iv) Adverse factors. The presence of any of the following factors 
will be considered as preventing the transferee ``from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes'' (within the meaning 
of paragraph (a)(7)(i) of this section):
    (A) Distributions. (1) With respect to distributions made after 
April 19, 1977, the transferor private foundation, a disqualified person 
with respect thereto, or any person or committee designated by, or 
pursuant to the terms of an agreement with, such a person (hereinafter 
referred to as donor), reserves the right, directly or indirectly, to 
name (other than by designation in the instrument of transfer of 
particular section 509(a)(1), (2), or (3) organizations) the persons to 
which the transferee public charity must distribute, or to direct the 
timing of such distributions (other than by direction in the instrument 
of transfer that some or all of the principal, as opposed to specific 
assets, not be distributed for a specified period) as, for example, by a 
power of appointment. The Internal Revenue Service will examine 
carefully whether the seeking of advice by the transferee from, or the 
giving of advice by, any donor after the assets have been transferred to 
the transferee constitutes an indirect reservation of a right to direct 
such distributions. In any such case, the reservation of such a right 
will be considered to exist where the only criterion considered by the 
public charity in making a distribution of income or principal from a 
donor's fund is advice offered by the donor. Whether there is a 
reservation of such a right will be determined from all of the facts and 
circumstances, including, but not limited to, the factors contained in 
paragraphs (a)(7)(iv)(A)(2) and (3) of this section.
    (2) The presence of some or all of the following factors will 
indicate that the reservation of such a right does not exist:
    (i) There has been an independent investigation by the staff of the 
public charity evaluating whether the donor's advice is consistent with 
specific charitable needs most deserving of support by the public 
charity (as determined by the public charity).
    (ii) The public charity has promulgated guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity and the donor's advice is consistent with such 
guidelines.
    (iii) The public charity has instituted an educational program 
publicizing to donors and other persons the guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity.
    (iv) The public charity distributes funds in excess of amounts 
distributed from the donor's fund to the same or similar types of 
organizations or charitable needs as those recommended by the donor.
    (v) The public charity's solicitations (written or oral) for funds 
specifically state that such public charity will not be bound by advice 
offered by the donor.
    (3) The presence of some or all of the following factors will 
indicate the reservation of such a right does exist:
    (i) The solicitations (written or oral) of funds by the public 
charity state or imply, or a pattern of conduct on the part of the 
public charity creates an expectation, that the donor's advice will be 
followed.
    (ii) The advice of a donor (whether or not restricted to a 
distribution of income or principal from the donor's trust or fund) is 
limited to distributions of amounts from the donor's fund, and the 
factors described in paragraph (a)(7)(iv)(A)(2)(i) or (ii) of this 
section are not present.
    (iii) Only the advice of the donor as to distributions of such 
donor's fund is solicited by the public charity and no procedure is 
provided for considering

[[Page 92]]

advice from persons other than the donor with respect to such fund.
    (iv) For the taxable year and all prior taxable years the public 
charity follows the advice of all donors with respect to their funds 
substantially all of the time.
    (B) Other action or withholding of action. The terms of the transfer 
agreement, or any expressed or implied understanding, required the 
public charity to take or withhold action with respect to the 
transferred assets which is not designed to further one or more of the 
exempt purposes of the public charity, and such action or withholding of 
action would, if performed by the transferor private foundation with 
respect to such assets, have subjected the transferor to tax under 
chapter 42 (other than with respect to the minimum investment return 
requirement of section 4942(e)).
    (C) Assumption of leases, contractual obligations, or liabilities. 
The public charity assumes leases, contractual obligations, or 
liabilities of the transferor private foundation, or takes the assets 
thereof subject to such liabilities (including obligations under 
commitments or pledges to donees of the transferor private foundation), 
for purposes inconsistent with the purposes or best interests of the 
public charity, other than the payment of the transferor's chapter 42 
taxes incurred prior to the transfer to the public charity to the extent 
of the value of the assets transferred.
    (D) Retention of investment assets. The transferee public charity is 
required by any restriction or agreement (other than a restriction or 
agreement imposed or required by law or regulatory authority), express 
or implied, to retain any securities or other investment assets 
transferred to it by the private foundation. In a case where such 
transferred assets consistently produce a low annual return of income, 
the Internal Revenue Service will examine carefully whether the 
transferee is required by any such restriction or agreement to retain 
such assets.
    (E) Right of first refusal. An agreement is entered into in 
connection with the transfer of securities or other property which 
grants directly or indirectly to the transferor private foundation or 
any disqualified person with respect thereto a right of first refusal 
with respect to the transferred securities or other property when and if 
disposed of by the public charity, unless such securities or other 
property was acquired by the transferor private foundation subject to 
such right of first refusal prior to October 9, 1969.
    (F) Relationships. An agreement is entered into between the 
transferor private foundation and the transferee public charity which 
establishes irrevocable relationships with respect to the maintenance or 
management of assets transferred to the public charity, such as 
continuing relationships with banks, brokerage firms, investment 
counselors, or other advisors with regard to the investments or other 
property transferred to the public charity (other than a relationship 
with a trustee, custodian, or agent for a community trust acting as 
such). The transfer of property to a public charity subject to 
contractual obligations which were established prior to November 11, 
1976, between the transferor private foundation and persons other than 
disqualified persons with respect to such foundation will not be treated 
as prohibited under the preceding sentence, but only if such contractual 
obligations were not entered into pursuant to a plan to terminate the 
private foundation status of the transferor under section 507(b)(1)(A) 
and if the continuation of such contractual obligations is in the best 
interests of the public charity.
    (G) Other conditions. Any other condition is imposed on action by 
the public charity which prevents it from exercising ultimate control 
over the assets received from the transferor private foundation for 
purposes consistent with its exempt purposes.
    (v) Examples. The provisions of this paragraph (a)(7) may be 
illustrated by the following examples:

    Example 1. The M Private Foundation transferred all of its net 
assets to the V Cancer Institute, a public charity described in section 
170(b)(1)(A)(iii). Prior to the transfer, M's activities consisted of 
making grants to hospitals and universities to further research into the 
causes of cancer. Under the terms of the transfer, V is required to keep 
M's assets in a separate fund and use the income and principal to 
further cancer research. Although the assets may be used only for a

[[Page 93]]

limited purpose, this purpose is consistent with and in furtherance of 
V's exempt purposes, and does not prevent the transfer from being a 
distribution for purposes of section 507(b)(1)(A).
    Example 2. The N Private Foundation transferred all of its net 
assets to W University, a public charity described in section 
170(b)(1)(A)(ii). Under the terms of the transfer, W is required to use 
the income and principal to endow a chair at the university to be known 
as the ``John J. Doe Memorial Professorship'', named after N's creator. 
Although the transferred assets are to be used for a specified purpose 
by W, this purpose is in furtherance of W's exempt educational purposes, 
and there are no conditions on investment or reinvestment of the 
principal or income. The use of the name of the foundation's creator for 
the chair is not a restriction which would prevent the transfer from 
being a distribution for purposes of section 507(b)(1)(A).
    Example 3. The O Private Foundation transferred all of its net 
assets to X Bank as trustee for the Q Community Trust, a community trust 
that is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, X is to hold the assets in trust for Q and is 
directed to distribute the income annually to the Y Church, a public 
charity described in section 170(b)(1)(A)(i). The distribution of income 
to Y Church is consistent with Q's exempt purposes. If the trust created 
by this transfer otherwise meets the requirements of Sec. 1.170A-
9T(f)(11) as a component part of the Q Community Trust, the assets 
transferred by O to X will be treated as distributed to one or more 
public charities within the meaning of section 507(b)(1)(A). The 
direction to distribute the income to Y Church meets the conditions of 
paragraph (a)(7)(iii)(B) of this section and will therefore not 
disqualify the transfer under section 507(b)(1)(A).
    Example 4. (i) The P Private Foundation transferred all of its net 
assets to Z Bank as trustee for the R Community Trust, a community trust 
that is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, Z is to hold the assets in trust for R and 
distribute the income to those public charities described in section 
170(b)(1)(A)(i) through (vi) that are designated by B, the creator of P. 
R's governing body has no authority during B's lifetime to vary B's 
direction. Under the terms of the transfer, it is intended that Z retain 
the transferred assets in their present form for a period of 20 years, 
or until the date of B's death if it occurs before the expiration of 
such period. Upon the death of B, R will have the power to distribute 
the income to such public charities as it selects and may dispose of the 
corpus as it sees fit.
    (ii) Under paragraph (a)(7)(iv)(A) or (D) of this section, as a 
result of the restrictions imposed with respect to the transferred 
assets, there has been no distribution of all P's net assets within the 
meaning of section 507(b)(1)(A) at the time of the transfer. In 
addition, P has not transferred its net assets to a component part of R 
Community Trust, but rather to a separate trust described in Sec. 
1.170A-9T(f)(12).

    (b) Operation as a public charity--(1) In general. Under section 
507(b)(1)(B), an organization can terminate its private foundation 
status if the organization--
    (i) Meets the requirements of section 509(a)(1), (2) or (3) for a 
continuous period of 60 calendar months beginning with the first day of 
any taxable year that begins after December 31, 1969;
    (ii) In compliance with section 507(b)(1)(B)(ii) and paragraph 
(b)(3) of this section, properly notifies the Internal Revenue Service, 
in such manner as may be provided by published guidance, publication, 
form or instructions, before the commencement of such 60-month period, 
that it is terminating its private foundation status; and
    (iii) Properly establishes immediately after the expiration of such 
60-month period that such organization has complied with the 
requirements of section 509(a)(1), (2) or (3) during the 60-month 
period, in the manner described in paragraph (b)(4) of this section.
    (2) Relationship of section 507(b)(1)(B) to section 507(a), (c), and 
(g). Because section 507(a) does not apply to a termination described in 
section 507(b)(1)(B), a private foundation's notification that it is 
commencing a termination pursuant to section 507(b)(1)(B) will not be 
treated as a notification described in section 507(a) even if the 
private foundation does not successfully terminate its private 
foundation status pursuant to section 507(b)(1)(B). A private foundation 
that terminates its private foundation status under section 507(b)(1)(B) 
does not incur tax under section 507(c) and, therefore, no abatement of 
such tax under section 507(g) is required.
    (3) Notification of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(ii), an organization shall 
before the commencement of the 60-month period under section 
507(b)(1)(B)(i) notify the Internal Revenue Service, in such manner as 
may

[[Page 94]]

be provided by published guidance, publication, form or instructions, of 
its intention to terminate its private foundation status. Such 
notification shall contain the following information:
    (i) The name and address of the private foundation.
    (ii) Its intention to terminate its private foundation status.
    (iii) The Code section under which it seeks classification (section 
509(a)(1), (2) or (3)).
    (iv) If section 509(a)(1) is applicable, the clause of section 
170(b)(1)(A) involved.
    (v) The date its regular taxable year begins.
    (vi) The date of commencement of the 60-month period.
    (4) Establishment of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(iii), an organization shall 
within 90 days after the expiration of the 60-month period file such 
information with the Internal Revenue Service, in such manner as may be 
provided by published guidance, publication, form or instructions, as is 
necessary to make a determination as to the organization's status as an 
organization described under section 509(a)(1), (2) or (3) and the 
accompanying regulations. See paragraph (c) of this section as to the 
information required to be submitted under this paragraph (b)(4).
    (5) Incomplete information. The failure to supply, within the 
required time, all of the information required by paragraph (b)(3) or 
(4) of this section is not alone sufficient to constitute a failure to 
satisfy the requirements of section 507(b)(1)(B). If the information 
that is submitted within the required time is incomplete and the 
organization supplies the necessary additional information at the 
request of the Commissioner within the additional time period allowed by 
him, the original submission will be considered timely.
    (6) Application of special rules and filing requirements. An 
organization that has terminated its private foundation status under 
section 507(b)(1)(B) is not required to comply with the special rules 
set forth in section 508(a) and (b). Such organization is also not 
required to file a return under the provisions of section 6043(b) or 
6050 by reason of termination of its private foundation status under the 
provisions of section 507(b)(1)(B).
    (7) Extension of time to assess deficiencies. If a private 
foundation files a notification (defined in paragraph (b)(3) of this 
section) that it intends to begin a 60-month termination pursuant to 
section 507(b)(1)(B) and does not file a request for an advance ruling 
pursuant to paragraph (d) of this section, such private foundation may 
file with the notification described in paragraph (b)(3) of this section 
a consent under section 6501(c)(4) to the effect that the period of 
limitation upon assessment under section 4940 for any taxable year 
within the 60-month termination period shall not expire prior to one 
year after the date of expiration of the time prescribed by law for the 
assessment of a deficiency for the last taxable year within the 60-month 
period. Such consents, if filed, will ordinarily be accepted by the 
Commissioner. See paragraph (e)(3) of this section for an illustration 
of the procedure required to obtain a refund of the tax imposed by 
section 4940 in a case where such a consent is not in effect.
    (c) Sixty-month terminations--(1) Method of determining normal 
sources of support. (i) In order to meet the requirements of section 
507(b)(1)(B) for the 60-month termination period as a section 509(a)(1) 
or (2) organization, an organization must meet the requirements of 
section 509(a)(1) or (2), as the case may be, for a continuous period of 
at least 60 calendar months. In determining whether an organization 
seeking status under section 509(a)(1) as an organization described in 
section 170(b)(1)(A)(iv) or (vi) or under section 509(a)(2) normally 
meets the requirements set forth under such sections, support received 
in taxable years prior to the commencement of the 60-month period shall 
not be taken into consideration, except as otherwise provided in this 
section.
    (ii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(1) organization described in section 
170(b)(1)(A)(vi) for a continuous period of 60 calendar months only if 
the organization satisfies the provisions of Sec. 1.170A-9T(f), other 
than Sec. 1.170A-

[[Page 95]]

9T(f)(4)(v), based upon aggregate data for such entire period. The 
calculation of public support shall be made over the period beginning 
with the date of the commencement of the 60-month period, and ending 
with the last day of the 60-month period.
    (iii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(2) organization only if such 
organization meets the support requirements set forth in section 
509(a)(2)(A) and (B) and the accompanying regulations, other than Sec. 
1.509(a)-3T(d), for the continuous period of 60 calendar months 
prescribed under section 507(b)(1)(B). The calculation of public support 
shall be made over the period beginning with the date of the 
commencement of the 60-month period, and ending with the last day of the 
60-month period.
    (2) Organizational and operational tests. In order to meet the 
requirements of section 507(b)(1)(B) for the 60-month termination period 
as an organization described in section 170(b)(1)(A)(i), (ii), (iii), 
(iv), or (v) or section 509(a)(3), as the case may be, an organization 
must meet the requirements of the applicable provisions for a continuous 
period of at least 60 calendar months. For purposes of section 
507(b)(1)(B), an organization will be considered to be such an 
organization only if it satisfies the requirements of the applicable 
provision (including with respect to section 509(a)(3), the 
organizational and operational test set forth in subparagraph (A) 
thereof) at the commencement of such 60-month period and continuously 
thereafter during such period.
    (d) Advance rulings for 60-month terminations--(1) In general. An 
organization that files the notification required by section 
507(b)(1)(B)(ii) that it is commencing a 60-month termination may obtain 
an advance ruling from the Commissioner that it can be expected to 
satisfy the requirements of section 507(b)(1)(B)(i) during the 60-month 
period. Such an advance ruling may be issued if the organization can 
reasonably be expected to meet the requirements of section 
507(b)(1)(B)(i) during the 60-month period. The issuance of a ruling 
will be discretionary with the Commissioner.
    (2) Basic consideration. In determining whether an organization can 
reasonably be expected (within the meaning of paragraph (d)(1) of this 
section) to meet the requirements of section 507(b)(1)(B)(i) for the 60-
month period, the basic consideration is whether its organizational 
structure (taking into account any revisions made prior to the beginning 
of the 60-month period), current or proposed programs or activities, 
actual or intended method of operation, and current or projected sources 
of support are such as to indicate that the organization is likely to 
satisfy the requirements of section 509(a)(1), (2), or (3) and paragraph 
(d) of this section during the 60-month period. In making such a 
determination, all pertinent facts and circumstances shall be 
considered.
    (3) Reliance by grantors and contributors. For purposes of sections 
170, 545(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522, grants 
or contributions to an organization which has obtained a ruling referred 
to in this paragraph will be treated as made to an organization 
described in section 509(a)(1), (2), or (3), as the case may be, until 
the Internal Revenue Service publishes notice that such advance ruling 
is being revoked (such as by publication in the Internal Revenue 
Bulletin). However, a grantor or contributor may not rely on such an 
advance ruling if the grantor or contributor was responsible for, or 
aware of, the act or failure to act that resulted in the organization's 
failure to meet the requirements of section 509(a)(1), (2), or (3), or 
acquired knowledge that the Internal Revenue Service had given notice to 
such organization that its advance ruling would be revoked. Prior to the 
making of any grant or contribution which allegedly will not result in 
the grantee's failure to meet the requirements of section 509(a)(1), 
(2), or (3), a potential grantee organization may request a ruling 
whether such grant or contribution may be made without such failure. A 
request for such ruling may be filed by the grantee organization with 
the Internal Revenue Service. The issuance of such ruling will be at the 
sole discretion of the Commissioner. The organization must submit all 
information necessary to make a

[[Page 96]]

determination on the factors referred to in paragraph (d)(2) of this 
section. If a favorable ruling is issued, such ruling may be relied upon 
by the grantor or contributor of the particular contribution in question 
for purposes of sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 2055, 
2106(a)(2), and 2522.
    (4) Reliance by organization. An organization obtaining an advance 
ruling pursuant to this paragraph cannot rely on such a ruling. 
Consequently, if the organization does not pay the tax imposed by 
section 4940 for any taxable year or years during the 60-month period, 
and it is subsequently determined that such tax is due for such year or 
years (because the organization did not in fact complete a successful 
termination pursuant to section 507(b)(1)(B) and was not treated as an 
organization described in section 509(a)(1), (2), or (3) for such year 
or years), the organization is liable for interest in accordance with 
section 6601 if any amount of tax under section 4940 has not been paid 
on or before the last date prescribed for payment. However, because any 
failure to pay such tax during the 60-month period (or prior to the 
revocation of such ruling) is due to reasonable cause, the penalty under 
section 6651 with respect to the tax imposed by section 4940 shall not 
apply.
    (5) Extension of time to assess deficiencies. The advance ruling 
described in paragraph (d)(1) of this section shall be issued only if 
such organization's request for an advance ruling is filed with a 
consent under section 6501(c)(4) to the effect that the period of 
limitation upon assessment under section 4940 for any taxable year 
within the advance ruling period shall not expire prior to 1 year after 
the date of the expiration of the time prescribed by law for the 
assessment of a deficiency for the last taxable year within the 60-month 
period.
    (e) Effect on grantors or contributors and on the organization 
itself--(1) Effect of satisfaction of requirements for termination; 
treatment during the termination period. In the event that an 
organization satisfies the requirements of section 507(b)(1)(B) for 
termination of its private foundation status during the continuous 60-
month period, such organization shall be treated for such entire 60-
month period in the same manner as an organization described in section 
509(a)(1), (2) or (3), as the case may be.
    (2) Failure to meet termination requirements--(i) In general. Except 
as otherwise provided in paragraphs (e)(2)(ii) and (d) of this section, 
any organization that fails to satisfy the requirements of section 
507(b)(1)(B) for termination of its private foundation status during the 
continuous 60-month period shall be treated as a private foundation for 
the entire 60-month period, for purposes of sections 507 through 509 and 
chapter 42, and grants or contributions to such an organization shall be 
treated as made to a private foundation for purposes of sections 170, 
507(b)(1)(A), 4942, and 4945.
    (ii) Certain 60-month terminations. Notwithstanding paragraph 
(e)(2)(i) of this section, if an organization fails to satisfy the 
requirements of section 509(a)(1), (2) or (3) for the continuous 60-
month period but does satisfy the requirements of section 509(a)(1), (2) 
or (3), as the case may be, for any taxable year or years during such 
60-month period, the organization shall be treated as a section 
509(a)(1), (2) or (3) organization for such taxable year or years and 
grants or contributions made during such taxable year or years shall be 
treated as made to an organization described in section 509(a)(1), (2) 
or (3). In addition, sections 507 through 509 and chapter 42 shall not 
apply to such organization for any taxable year within such 60-month 
period for which it does meet such requirements. For purposes of 
determining whether an organization satisfies the requirements of 
section 509(a)(1), (2) or (3) for any taxable year in the 60-month 
period, the calculation of public support shall be made over the period 
beginning with the date of the commencement of the 60-month period, and 
ending with the last day of the taxable year being tested. The 
organization shall not be treated as a section 509(a)(1) or (2) 
organization for any taxable year during the 60-month period solely by 
reason of having met a public support test for the preceding year. In 
addition, the transition rules in Sec. 1.170-9T(f)(14)(iii) and Sec. 
1.509(a)-3T(n)(iii) shall not apply.

[[Page 97]]

    (iii) Aggregate tax benefit. For purposes of section 507(d), the 
organization's aggregate tax benefit resulting from the organization's 
section 501(c)(3) status shall continue to be computed from the date 
from which such computation would have been made, but for the notice 
filed under section 507(b)(1)(B)(ii), except that any taxable year 
within such 60-month period for which such organization meets the 
requirements of section 509(a)(1), (2), or (3) shall be excluded from 
such computations.
    (iv) Excess business holdings. See section 4943 and the accompanying 
regulations for rules relating to decreases in a private foundation's 
holdings in a business enterprise which are caused by the foundation's 
failure to terminate its private foundation status after giving the 
notification for termination under section 507(b)(1)(B)(ii).
    (3) Example. The provisions of this paragraph (e) may be illustrated 
by the following example:

    Example. Y, a calendar year private foundation, notifies the 
Internal Revenue Service that it intends to terminate its private 
foundation status by converting into a publicly supported organization 
described in section 170(b)(1)(A)(vi) and that its 60-month termination 
period will commence on January 1, 2010. Y does not obtain a ruling 
described in paragraph (d) of this section. Based upon its support for 
2010, Y does not qualify as a publicly supported organization within the 
meaning of Sec. 1.170A-9T(f) and this paragraph for 2010. Consequently, 
in order to avoid the risks of penalties and interest if Y fails to 
terminate within the 60-month period, Y files its 2010 return as a 
private foundation and pays the tax imposed by section 4940. Because a 
consent (described in paragraph (b)(7) of this section), which would 
prevent the period of limitations for all years in the 60-month period 
from expiring, is not in effect, in order to be able to file a claim for 
refund, Y and the Internal Revenue Service must agree to extend the 
period of limitation for all taxes imposed under chapter 42 for 2010. 
Based on the aggregate data for the entire 60-month period (2010 through 
2014), Y does qualify as a publicly-supported organization for the 
entire 60-month period. Consequently, Y is treated as a publicly-
supported organization for the entire 60-month period. Y files a claim 
for refund for the taxes paid under section 4940 for 2010, and such 
taxes are refunded.

    (f) Effective/applicability date--(1) Effective date. These 
regulations are effective on September 9, 2008.
    (2) Applicability date. The regulations in this section shall apply 
to taxable years beginning on or after January 1, 2008.
    (3) Expiration date. The applicability of this section expires on 
September 8, 2011.

[T.D. 9423, 73 FR 52544, Sept. 9, 2008]



Sec. 1.507-3  Special rules; transferee foundations.

    (a) General rule. (1) For purposes of part II, subchapter F, chapter 
1 of the Code, in the case of a transfer of assets of any private 
foundation to another private foundation pursuant to any liquidation, 
merger, redemption, recapitalization, or other adjustment, organization, 
or reorganization, the transferee organization shall not be treated as a 
newly created organization. Thus, in the case of a significant 
disposition of assets to one or more private foundations within the 
meaning of paragraph (c) of this section, the transferee organization 
shall not be treated as a newly created organization. A transferee 
organization to which this paragraph applies shall be treated as 
possessing those attributes and characteristics of the transferor 
organization which are described in subparagraphs (2), (3), and (4) of 
this paragraph.
    (2)(i) A transferee organization to which this paragraph applies 
shall succeed to the aggregate tax benefit of the transferor 
organization in an amount determined as follows: Such amount shall be an 
amount equal to the amount of such aggregate tax benefit multiplied by a 
fraction the numerator of which is the fair market value of the assets 
(less encumbrances) transferred to such transferee and the denominator 
of which is the fair market value of the assets of the transferor (less 
encumbrances) immediately before the transfer. Fair market value shall 
be determined as of the time of the transfer.
    (ii) Notwithstanding subdivision (i) of this subparagraph, a 
transferee organization which is not effectively controlled (within the 
meaning of Sec. 1.482-1(a)(3)), directly or indirectly, by the same 
person or persons who effectively control the transferor organization

[[Page 98]]

shall not succeed to an aggregate tax benefit in excess of the fair 
market value of the assets transferred at the time of the transfer.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. Pursuant to a transfer described in section 507(b)(2), F, 
a private foundation, transfers to G, a private foundation, all of its 
assets, which have a fair market value of $400,000. Immediately before 
the transfer F's aggregate tax benefit was $200,000, and G's aggregate 
tax benefit was $300,000. After the transfer G's aggregate tax benefit 
is $500,000 ($200,000+$300,000).
    Example 2. Pursuant to a transfer described in section 507(b)(2), M, 
a private foundation, transfers all of its assets, which immediately 
prior to the transfer have a fair market value of $100,000. The assets 
were transferred to the following organizations at the following fair 
market values (determined at the time of transfer) $40,000 to N, a 
private foundation, $30,000 to O, a private foundation, and $30,000 to 
P, an organization described in section 170(b)(1)(A)(vi). Immediately 
before the transfer M's aggregate tax benefit was $50,000. Therefore, N 
succeeds to M's aggregate tax benefit to the extent of $20,000 
($50,000x$40,000/$100,000) and O succeeds to M's aggregate tax benefit 
to the extent of $15,000 ($50,000x$30,000/$100,000). The remaining 
$15,000 of M's aggregate tax benefit is retained by M as M has not 
terminated under section 507.
    Example 3. Assume the same facts as in Example 2 except that the 
transfers were made as follows: M transferred $30,000 to N on January 1, 
1972, $40,000 to P on July 1, 1972, and $30,000 to O on December 31, 
1972. Further, assume that the fair market value of the assets and the 
aggregate tax benefit do not change during 1972 and that O is not 
effectively controlled (directly or indirectly) by the same person or 
persons who effectively control M. N succeeds to M's aggregate tax 
benefit to the extent of $15,000 ($50,000x$30,000/$100,000). However, 
since $40,000 of the remaining $70,000 ($100,000-$30,000) of assets of M 
was transferred to P on July 1, 1972, immediately before the transfer to 
O, the fair market value of the assets held by M is $30,000 ($70,000-
$40,000). On the other hand, because P is not a private foundation, M's 
aggregate tax benefit immediately before the transfer to O remains 
$35,000 ($50,000-$15,000). Therefore, before applying subdivision (ii) 
of this subparagraph, O would succeed to $35,000 ($35,000x$30,000/
$30,000) of M's aggregate tax benefit. However, applying subdivision 
(ii) of this subparagraph since M transferred only $30,000 to O, O shall 
succeed to only $30,000 of M's aggregate tax benefit. The remaining 
$5,000 ($35,000-$30,000) of M's aggregate tax benefit is retained by M 
as M has not terminated under section 507.

    (3) For purposes of section 507(d)(2), in the event of a transfer of 
assets described in section 507(b)(2), any person who is a substantial 
contributor (within the meaning of section 507(d)(2)) with respect to 
the transferor foundation shall be treated as a substantial contributor 
with respect to the transferee foundation, regardless of whether such 
person meets the $5,000-two percent test with respect to the transferee 
organization at any time. If a private foundation makes a transfer 
described in section 507(b)(2) to two or more transferee private 
foundations, any person who is a substantial contributor with respect to 
the transferor foundation prior to such transfer shall be considered a 
substantial contributor with respect to each transferee private 
foundation.
    (4) If a private foundation incurs liability for one or more of the 
taxes imposed under chapter 42 (or any penalty resulting therefrom) 
prior to, or as a result of, making a transfer of assets described in 
section 507(b)(2) to one or more private foundations, in any case where 
transferee liability applies each transferee foundation shall be treated 
as receiving the transferred assets subject to such liability to the 
extent that the transferor foundation does not satisfy such liability.
    (5) Except as provided in subparagraph (9) of this paragraph, a 
private foundation is required to meet the distribution requirements of 
section 4942 for any taxable year in which it makes a section 507(b)(2) 
transfer of all or part of its net assets to another private foundation. 
Such transfer shall itself be counted toward satisfaction of such 
requirements to the extent the amount transferred meets the requirements 
of section 4942(g). However, where the transferor has disposed of all of 
its assets, the recordkeeping requirements of section 4942(g)(3)(B) 
shall not apply during any period in which it has no assets. Such 
requirements are applicable for any taxable year other than a taxable 
year during which the transferor has no assets.
    (6) For purposes of section 4943(c) (4), (5), and (6), whenever a 
private foundation makes a section 507(b)(2) transfer

[[Page 99]]

of all or part of its net assets to another private foundation, the 
applicable period of time described in section 4943(c) (4), (5), or (6) 
shall include both the period during which the transferor foundation 
held such assets and the period during which the transferee foundation 
holds such assets.
    (7) Except as provided in subparagraph (9) of this paragraph, where 
the transferor has disposed of all of its assets, during any period in 
which the transferor has no assets, section 4945 (d)(4) and (h) shall 
not apply to the transferee or the transferor with respect to any 
expenditure responsibility grants made by the transferor. However, the 
exception contained in this subparagraph shall not apply with respect to 
any information reporting requirements imposed by section 4945 and the 
regulations thereunder for any year in which any such transfer is made.
    (8)(i) Except as provided in subdivision (ii) of this subparagraph 
or subparagraph (6) or (9) of this paragraph or whenever a private 
foundation makes a transfer of assets described in section 507(b)(2) to 
one or more private foundations, the transferee foundation:
    (a) Will not be treated as being in existence prior to January 1, 
1970, with respect to any transferred assets;
    (b) Will not be treated as holding the transferred assets prior to 
January 1, 1970; and
    (c) Will not be treated as having engaged in, or become subject to, 
any transaction, lease, contract, or other obligation with respect to 
the transferred assets prior to January 1, 1970.
    (ii) Notwithstanding subdivision (i) of this subparagraph, the 
provisions enumerated in (a) through (g) of this subdivision shall apply 
to the transferee foundation with respect to the assets transferred to 
the same extent and in the same manner that they would have applied to 
the transferor foundation had the transfer described in section 
507(b)(2) not been effected:
    (a) Section 4940(c)(4)(B) and the regulations thereunder with 
respect to basis of property,
    (b) Section 4942(f)(4) and the regulations thereunder with respect 
to distributions of income,
    (c) Section 101(l)(2) of the Tax Reform Act of 1969 (83 Stat. 533), 
as amended by sections 1301 and 1309 of the Tax Reform Act of 1976 (90 
Stat. 1713, 1729), with respect to the provisions of section 4941,
    (d) Section 101(l)(3)(A) of the Tax Reform Act of 1969 (83 Stat. 
534) with respect to the provisions of section 4942, but only if the 
transferor qualified for the application of such section immediately 
before the transfer, and at least 85 percent of the fair market value of 
the net assets of the transferee immediately after the transfer was 
received pursuant to the transfer,
    (e) Section 101(l)(3) (B) through (E) of the Tax Reform Act of 1969 
(83 Stat. 534) with respect to the provisions of section 4942,
    (f) Section 101(l)(5) of the Tax Reform Act of 1969 (83 Stat. 535) 
with respect to the provisions of section 4945, and
    (g) Section 101(l)(6) of the Tax Reform Act of 1969 (83 Stat. 535) 
with respect to the provisions of section 508(e).
    (9) (i) If a private foundation transfers all of its net assets to 
one or more private foundations which are effectively controlled (within 
the meaning of Sec. 1.482-1(a)(3)), directly or indirectly, by the same 
person or persons which effectively controlled the transferor private 
foundation, for purposes of chapter 42 (section 4940 et seq.) and part 
II of subchapter F of chapter 1 of the Code (sections 507 through 509) 
such a transferee private foundation shall be treated as if it were the 
transferor. However, where proportionality is appropriate, such a 
transferee private foundation shall be treated as if it were the 
transferor in the proportion which the fair market value of the assets 
(less encumbrances) transferred to such transferee bears to the fair 
market value of the assets (less encumbrances) of the transferor 
immediately before the transfer.
    (ii) Subdivision (i) of this subparagraph shall not apply to the 
requirements under sections 6033, 6056, and 6104 which must be complied 
with by the transferor private foundation, nor to the requirement under 
section 6043 that the transferor file a return with respect to its 
liquidation, dissolution, or termination.

[[Page 100]]

    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. The trustees of X charitable trust, a private foundation, 
form the Y charitable corporation, also a private foundation, in order 
to facilitate the conduct of their activities. The trustees of X are 
also the directors of Y. Y has the same charitable purposes as X. All of 
the assets of X are transferred to Y, and Y continues to carry on X's 
charitable activities. Under such circumstances, Y shall be treated as 
if it were X for the purposes of subdivision (i) of this subparagraph. 
Thus, for example, Y will be permitted to take advantage of any special 
rules or savings provisions with respect to chapter 42 to the same 
extent as X could have if X had continued in existence.
    Example 2. A and B are the trustees of the P charitable trust, a 
private foundation, and are the only substantial contributors to P. On 
July 1, 1973, in order to facilitate accomplishment of diverse 
charitable purposes, A and B create and control the R Foundation, the S 
Foundation and the T Foundation and transfer the net assets of P to R, 
S, and T. As of the end of 1973, P has an outstanding grant to 
Foundation W and has been required to exercise expenditure 
responsibility with respect to this grant under sections 4945 (d)(4) and 
(h). Under these circumstances, R, S, and T shall each be treated as if 
they are P in the proportion the fair market value of the assets 
transferred to each bears to the fair market value of the assets of P 
immediately before the transfer. Since R, S, and T are treated as P, 
absent a specific provision for exercising expenditure responsibility 
with respect to the grant to W, each of them is required to exercise 
expenditure responsibility with respect to such grant. If, as a part of 
the transfer to R, P assigned, and R assumed, P's duties with respect to 
the expenditure responsibility grant to W, only R would be required to 
exercise expenditure responsibility with respect to the grant to W. 
Since R, S, and T are treated as P rather than as recipients of 
expenditure responsibility grants, there are no expenditure 
responsibility requirements which must be exercised under sections 4945 
(d)(4) and (h) with respect to the transfers of assets to R, S, and T.

    (10) For certain rules relating to filing requirements where a 
private foundation has transferred all its net assets, see Sec. 1.507-
1(b)(9).
    (b) Status of transferee organization under section 507(b)(2). Since 
a transfer of assets pursuant to any liquidation, merger, redemption, 
recapitalization, or other adjustment, organization or reorganization to 
an organization not described in section 501(c)(3) (other than an 
organization described in section 509(a)(4)) or 4947 is a taxable 
expenditure under section 4945(d)(5), in order for such a transfer of 
assets not to be a taxable expenditure, it must be to an organization 
described in section 501(c)(3) (other than an organization described in 
section 509(a)(4)) or treated as described in section 501(c)(3) under 
section 4947. See Sec. 53.4945-6(c)(3) of this chapter. Consequently, 
unless such a transferee is an organization described in section 509(a) 
(1), (2), or (3), the transferee is a private foundation and the rules 
of section 507(b)(2) and paragraph (a) of this section apply. On the 
other hand, if such a transfer of assets is made to a transferee 
organization which is not described in either section 501(c)(3) (other 
than an organization described in section 509(a)(4)) or 4947, and in 
order to correct the making of a taxable expenditure, such assets are 
transferred to a private foundation, section 507(b)(2) and paragraph (a) 
of this section shall apply as if the transfer of assets had been made 
directly to such private foundation.
    (c) Section 507(b)(2) transfers. (1) A transfer of assets is 
described in section 507(b)(2) if it is made by a private foundation to 
another private foundation pursuant to any liquidation, merger, 
redemption, recapitalization, or other adjustment, organization, or 
reorganization. This shall include any organization or reorganization 
described in subchapter C of chapter 1. For purposes of section 
507(b)(2), the terms other adjustment, organization, or reorganization 
shall include any partial liquidation or any other significant 
disposition of assets to one or more private foundations, other than 
transfers for full and adequate consideration or distributions out of 
current income. For purposes of this paragraph, a distribution out of 
current income shall include any distribution described in section 
4942(h)(1) (A) and (B).
    (2) The term significant disposition of assets to one or more 
private foundations shall include any disposition for a taxable year 
where the aggregate of:
    (i) The dispositions to one or more private foundations for the 
taxable year, and
    (ii) Where any disposition to one or more private foundations for 
the taxable year is part of a series of related

[[Page 101]]

dispositions made during prior taxable years, the total of the related 
dispositions made during such prior taxable years, is 25 percent or more 
of the fair market value of the net assets of the foundation at the 
beginning of the taxable year (in the case of subdivision (i) of this 
subparagraph) or at the beginning of the first taxable year in which any 
of the series of related dispositions was made (in the case of 
subdivision (ii) of this subparagraph). A significant disposition of 
assets may occur in a single taxable year (as in subdivision (i) of this 
subparagraph) or over the course of two or more taxable years (as in 
subdivision (ii) of this subparagraph). The determination whether a 
significant disposition has occurred through a series of related 
distributions (within the meaning of subdivision (ii) of this 
subparagraph) will be made on the basis of all the facts and 
circumstances of the particular case. However, if one or more persons 
who are disqualified persons (within the meaning of section 4946) with 
respect to the transferor private foundation are also disqualified 
persons with respect to any of the transferee private foundations, such 
fact shall be evidence that the transfer is part of a series of related 
dispositions (within the meaning of subdivision (ii) of this 
subparagraph). In the case of a series of related dispositions described 
in subdivision (ii) of this subparagraph, each transferee private 
foundation shall (on any date) be subject to the provisions of section 
507(b)(2) (with respect to all such dispositions made to it on or before 
such date) to the extent described in paragraphs (a) and (b) of this 
section.
    (3) A private foundation which fails to meet the requirements of 
section 507(b)(1)(A) for a taxable year may be required to file a return 
under section 6043(b) by reason of a transfer of assets to one or more 
sections 509(a) (1), (2), or (3) organizations. Hence, such filing does 
not necessarily mean that a section 507(b)(2) transfer has occurred. See 
Sec. 1.6043-3(f)(1).
    (4) This paragraph applies to any section 507(b)(2) transfer made by 
a private foundation referred to in section 170(b)(1)(E) (i), (ii), or 
(iii).
    (5) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. M is a private foundation on the calendar year basis. It 
has net assets worth $100,000 as of January 1, 1971. In 1971, in 
addition to distributions out of current income, M transfers $10,000 to 
N, $10,000 to O, and $10,000 to P. N, O, and P are all private 
foundations. Under subparagraph (2)(i) of this paragraph, M has made a 
significant disposition of its assets in 1971 since M has disposed of 
more than 25 percent of its net assets (with respect to the fair market 
value of such assets as of January 1, 1971). M has therefore made 
section 507(b)(2) transfers within the meaning of this paragraph, and 
section 507(b)(2) applies to the transfers made to N, O, and P.
    Example 2. U, a tax-exempt private foundation on the calendar year 
basis, has net assets worth $100,000 as of January 1, 1971. As part of a 
series of related dispositions in 1971 and 1972, U transfers in 1971, in 
addition to distributions out of current income, $10,000 to private 
foundation X and $10,000 to private foundation Y, and in 1972, in 
addition to distributions out of current income, U transfers $10,000 to 
private foundation Z. Under subparagraph (2)(ii) of this paragraph, U is 
treated as having made a series of related dispositions in 1971 and 
1972. The aggregate of the 1972 disposition (under subparagraph (2)(i) 
of this paragraph) and the series of related dispositions (under 
subparagraph (2)(ii) of this paragraph) is $30,000, which is more than 
25 percent of the fair market value of U's net assets as of the 
beginning of 1971 ($100,000), the first year in which any such 
disposition was made. Thus, U has made a significant disposition of its 
assets and has made transfers described in section 507(b)(2). The 
provisions of paragraphs (a) and (b) of this section apply to each of 
the transferees as of the date on which it received assets from U.

    (d) Inapplicability of section 507(a) to section 507(b)(2) 
transfers. Unless a private foundation voluntarily gives notice pursuant 
to section 507(a)(1), a transfer of assets described in section 
507(b)(2) will not constitute a termination of the transferor's private 
foundation status under section 507(a)(1). Such transfer must, 
nevertheless, satisfy the requirements of any pertinent provisions of 
chapter 42. See subparagraphs (5) through (7) of paragraph (a) of this 
section. However, if such transfer constitutes an act or failure to act 
which is described in section 507(a)(2)(A), then such transfer will be 
subject to the provisions of section

[[Page 102]]

507(a)(2) rather than section 507(b)(2). For example, X, a private 
nonoperating foundation, transfers all of its net assets to Y, a private 
operating foundation, in 1971. X does not file the notice referred to in 
section 507(a)(1) and the transfer does not constitute either a willful 
and flagrant act (or failure to act), or one of a series of willful 
repeated acts (or failures to act), giving rise to liability for tax 
under chapter 42. Under these circumstances, the transfer is described 
in section 507(b)(2) and the provisions of paragraph (a) of this section 
apply with respect to Y. The private foundation status of X has not been 
terminated under section 507(a).
    (e) Transfers to certain section 509(a) (1), (2), or (3) 
organizations. If a private foundation transfers all or part of its 
assets to one or more organizations described in section 509(a) (1), 
(2), or (3) and, within a period of 3 years from the date of such 
transfers, one or more of the transferee organizations lose their 
section 509(a) (1), (2), or (3) status and become private foundations, 
then for purposes of this section, a transfer of assets within the 
meaning of paragraph (c) of this section to such an organization which 
becomes a private foundation will be treated as a transfer described in 
section 507(b)(2), and the provisions of paragraph (a) of this section 
shall be treated as applying to such a transferee organization from the 
date on which any such transfer was made to it.
    (f) Certain transfers made during section 507(b)(1)(B) terminations. 
If:
    (1) During the course of the 12-month or 60-month period described 
in section 507(b)(1)(B), a private foundation makes one or more 
transfers to one or more private foundations;
    (2) Such transfers are described in Sec. 1.507-3(c)(1); and
    (3) Even though the transferor foundation thereafter meets the 
requirements of section 507(b)(1)(B)


then for purposes of this section, the provisions of Sec. 1.507-2(e) 
shall not apply with respect to such transfers, and such transfers will 
be treated as transfers described in section 507(b)(2) and Sec. 1.507-3 
rather than as transfers from an organization described in section 
509(a) (1), (2), or (3).

[T.D. 7233, 37 FR 28158, Dec. 21, 1972; 38 FR 3189, Feb. 2, 1973, as 
amended by T.D. 7678, 45 FR 12415, Feb. 26, 1980]



Sec. 1.507-4  Imposition of tax.

    (a) General rule. Section 507(c) imposes on each organization the 
private foundation status of which is terminated under section 507(a) a 
tax equal to the lower of:
    (1) The amount which such organization substantiates by adequate 
records (or other corroborating evidence which may be required by the 
Commissioner) as the aggregate tax benefit (as defined in section 
507(d)) resulting from the section 501(c)(3) status of such 
organization, or
    (2) The value of the net assets of such organization.
    (b) Transfers not subject to section 507(c). Private foundations 
which make transfers described in section 507(b)(1)(A) or (2) are not 
subject to the tax imposed under section 507(c) with respect to such 
transfers unless the provisions of section 507(a) become applicable. See 
Sec. Sec. 1.507-1(b), 1.507-2(a)(6) and 1.507-3(d).

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec. 1.507-5  Aggregate tax benefit; in general.

    (a) General rule. For purposes of section 507(c)(1), the aggregate 
tax benefit resulting from the section 501(c)(3) status of any private 
foundation is the sum of:
    (1) The aggregate increases in tax under chapters 1, 11, and 12 (or 
the corresponding provisions of prior law) which would have been imposed 
with respect to all substantial contributors to the foundation if 
deductions for all contributions made by such contributors to the 
foundation after February 28, 1913, had been disallowed,
    (2) The aggregate increases in tax under chapter 1 (or the 
corresponding provisions of prior law) which would have been imposed 
with respect to the income of the private foundation for taxable years 
beginning after December 31, 1912, if (i) it had not been exempt from 
tax under section 501(a) (or the corresponding provisions of prior

[[Page 103]]

law), and (ii) in the case of a trust, deductions under section 642(c) 
(or the corresponding provisions of prior law) had been limited to 20 
percent of the taxable income of the trust (computed without the benefit 
of section 642(c) but with the benefit of section 170(b)(1)(A)),
    (3) The amount succeeded to from transferors under Sec. 1.507-3(a) 
and section 507(b)(2), and
    (4) Interest on the increases in tax determined under subparagraphs 
(1), (2), and (3) of this paragraph from the first date on which each 
such increase would have been due and payable to the date on which the 
organization ceases to be a private foundation.
    (b) Contributions. In computing the amount of the aggregate 
increases in tax under subparagraph (1) of this paragraph, all 
deductions attributable to a particular contribution shall be included. 
For example, if a substantial contributor has taken deductions under 
sections 170 and 2522 (or the corresponding provisions of prior law) 
with respect to the same contribution, the amount of each deduction 
shall be included in the computations under section 507(d)(1)(A). 
Accordingly, the aggregate tax benefit may exceed the fair market value 
of the property transferred.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec. 1.507-6  Substantial contributor defined.

    (a) Definition--(1) In general. Except as provided in subparagraph 
(2) of this paragraph, the term substantial contributor means, with 
respect to a private foundation, any person (within the meaning of 
section 7701(a)(1)), whether or not exempt from taxation under section 
501(a), who contributed or bequeathed an aggregate amount of more than 
$5,000 to the private foundation, if such amount is more than 2 percent 
of the total contributions and bequests received by the private 
foundation before the close of the taxable year of the private 
foundation in which a contribution or bequest is received by the 
foundation from such person. In the case of a trust, the term 
substantial contributor also means the creator of the trust. Such term 
does not include a governmental unit described in section 170(c)(1).
    (2) Special rules. For purposes of sections 170(b)(1)(E)(iii), 
507(d)(1), 508(d), 509(a) (1) and (3), and chapter 42, the term 
substantial contributor 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. Furthermore, taking section 4941 (relating to taxes on 
self-dealing) in context, it would unduly restrict the activities of 
private foundations if the term substantial contributor were to include 
any section 501(c)(3) organizations. It was not intended, for example, 
that a large grant for charitable purposes from one private foundation 
to another world forever preclude the latter from making any grants to, 
or otherwise dealing with, the former. Accordingly, for purposes of 
section 4941 only, the term substantial contributor shall not only 
include any organization which is described in section 501(c)(3) (other 
than an organization described in section 509(a)(4)).
    (b) Determination of substantial contributor--(1) In general. In 
determining under paragraph (a) of this section whether the aggregate of 
contributions and bequests from a person exceeds 2 percent of the total 
contributions and bequests received by a private foundation, both the 
total of such amounts received by the private foundation, and the 
aggregate of such amounts contributed and bequeathed by such person, 
shall be determined as of the last day of each taxable year commencing 
with the first taxable year ending after October 9, 1969. Generally, 
under section 507(d)(2) and this section, except for purposes of 
valuation under section 507(d)(2)(B)(i), all contributions and bequests 
made before October 9, 1969, are deemed to have been made on October 9, 
1969. For purposes of section 509(a)(2) and the support test described 
in Sec. 1.509(a)-3(c), contributions and bequests before October 9, 
1969, will be taken into account in the year when actually made. For 
example, in the case of a contribution or bequest of $6,000 in 1967, 
such contribution or bequest shall be treated as made by a substantial 
contributor in 1967 for purposes of section 509(a)(2) and Sec. 
1.509(a)-

[[Page 104]]

3(c) if such person met the $5,000--2 percent test as of December 31, 
1967, and December 31, 1969 (in the case of a calendar year accounting 
period). Although the determination of the percentage of total 
contributions and bequests represented by a given donor's contributions 
and bequests is not made until the end of the foundation's taxable year, 
a donor is a substantial contributor as of the first date when the 
foundation received from him an amount sufficient to make him a 
substantial contributor. Except as otherwise provided in this 
subparagraph, such amount is treated for all purposes as made by a 
substantial contributor. Thus, the total contributions and bequests 
received by the private foundation from all persons, and the aggregate 
contributions and bequests made by a particular person, are to be 
determined as of December 31, 1969 (in the case of a calendar year 
organization which was in existence on that date), and the amounts 
included in each respective total would be all contributions and 
bequests received by the organization on or before that date, and all 
contributions and bequests made by the person on or before that date. 
Thereafter, a similar determination is to be made with respect to such 
private foundation as of the end of each of its succeeding taxable 
years. Status as a substantial contributor, however, will date from the 
time when the donor first met the $5,000 and 2 percent test. Once a 
person is a substantial contributor with respect to a private 
foundation, he remains a substantial contributor even though he might 
not be so classified if a determination were first made at some later 
date. For instance, even though the aggregate contributions and bequests 
of a person become less than 2 percent of the total received by a 
private foundation (for example, because of subsequent contributions and 
bequests by other persons), such person remains a substantial 
contributor with respect to the foundation.
    (2) Examples. The provisions of paragraph (a) of this section and 
this paragraph (b) may be illustrated by the following examples:

    Example 1. On January 1, 1968, A, an individual, gave $4,500 to M, a 
private foundation on a calendar year basis. On June 1, 1969, A gave M 
the further sum of $1,500. Throughout its existence, through December 
31, 1969, M has received $250,000 in contributions and bequests from all 
sources. As of June 1, 1969, A is a substantial contributor to M for 
purposes of section 509(a)(2).
    Example 2. On September 9, 1966, B, an individual, gave $3,500 to N, 
a private foundation on a calendar year basis. On March 15, 1970, B gave 
N the further sum of $3,500. Throughout its existence, through December 
31, 1970, N has received $200,000 in contributions and bequests from all 
sources. B is a substantial contributor to N as of March 15, 1970, since 
that is the first date on which his contributions met the 2 percent-
$5,000 test.
    Example 3. On July 21, 1964, X, a corporation, gave $2,000 to O, a 
private foundation on a calendar year basis. As of December 31, 1969, O 
had received $150,000 from all sources. On September 17, 1970, X gave O 
the further sum of $3,100. Through September 17, 1970, O had received 
$245,000 from all sources as total contributions and bequests. Between 
September 17, 1970, and December 31, 1970, however, O received $50,000 
in contributions and bequests from others. X is not a substantial 
contributor to O, since X's contributions to O were not more than 2 
percent of the total contributions and bequests received by O by 
December 31, 1970, the end of O's taxable year, even though X's 
contributions met that test at one point during the year.
    Example 4. On September 16, 1970, C, an individual, gave $10,000 to 
P, a private foundation on a calendar year basis. Throughout its 
existence, and through December 31, 1970, the close of its taxable year, 
P had received a total of $100,000 in contributions and bequests. On 
January 3, 1971, P received a bequest of $1 million. C is a substantial 
contributor to P since he was a substantial contributor as of September 
16, 1970, and therefore remains one even though he no longer meets the 
2-percent test on a later date after the end of the taxable year of the 
foundation in which he first became a substantial contributor.

    (c) Special rules--(1) Contributions defined. The term contribution 
shall, for purposes of section 507(d)(2), have the same meaning as such 
term has under section 170(c) and also include bequests, legacies, 
devises, and transfers within the meaning of section 2055 or 2106(a)(2). 
Thus, for purposes of section 507(d)(2), any payment of money or 
transfer of property without adequate consideration shall be considered 
a contribution. Where payment is made or property transferred as 
consideration for admissions, sales of merchandise, performance of 
services, or furnishing

[[Page 105]]

of facilities to the donor, the qualification of all or any part of such 
payment or transfer as a contribution under section 170(c) shall 
determine whether and to what extent such payment or transfer 
constitutes a contribution under section 507(d)(2).
    (2) Valuation of contributions and bequests. Each contribution or 
bequest to a private foundation shall be valued at fair market value 
when actually received by the private foundation.
    (3) Contributions and bequests by a spouse. An individual shall be 
considered, for purposes of this section, to have made all contributions 
and bequests made by his spouse during the period of their marriage. 
Thus, for example, where W contributed $500,000 to P, a private 
foundation, in 1941 and that amount exceeded 2 percent of the total 
contributions received by P as of the end of P's first taxable year 
ending after October 9, 1969, H (W's spouse at the time of the 1941 
gift) is considered to have made such contribution (even if W died prior 
to October 9, 1969, or their marriage was otherwise terminated prior to 
such date). Similarly, any bequest or devise shall be treated as having 
been made by the decedent's surviving spouse.

[T.D. 7241, 37 FR 28743, Dec. 29, 1972; 38 FR 24206, Sept. 6, 1973]



Sec. 1.507-7  Value of assets.

    (a) In general. For purposes of section 507(c), the value of the net 
assets shall be determined at whichever time such value is higher:
    (1) The first day on which action is taken by the organization which 
culminates in its ceasing to be a private foundation, or
    (2) The date on which it ceases to be a private foundation.
    (b) Valuation dates. (1) In the case of a termination under section 
507(a)(1), the date referred to in paragraph (a)(1) of this section 
shall be the date on which the terminating foundation gives the 
notification described in section 507(a)(1).
    (2) In the case of a termination under section 507(a)(2), the date 
referred to in paragraph (a)(1) of this section shall be the date of 
occurrence of the willful and flagrant act (or failure to act) or the 
first of the series of willful repeated acts (or failures to act) giving 
rise to liability for tax under chapter 42 and the imposition of tax 
under section 507(a)(2).
    (c) Fair market value. For purposes of this section, fair market 
value shall be determined pursuant to the provisions of Sec. 
53.4942(a)-2(c)(4) of this chapter.
    (d) Net assets. For purposes of section 507 and the regulations 
thereunder, the term net assets shall mean the gross assets of a private 
foundation reduced by all liabilities of the foundation, including 
appropriate estimated and contingent liabilities. Thus, a determination 
of net assets may reflect reductions for any liability or contingent 
liability for tax imposed upon the private foundation under chapter 42 
with respect to acts or failures to act prior to termination, for any 
liability or contingent liability for failures to correct such acts or 
failures to act, or for any liability or estimated or contingent 
liability with respect to expenses associated with winding up the 
organization. If a private foundation's determination of net assets 
reflects any reduction for any estimated or contingent liability, such 
private foundation must establish, to the satisfaction of the 
Commissioner, the reasonableness of such reduction. If the amount of net 
assets reflects a reduction for any estimated or contingent liability, 
at the earlier of the final determination of the contingency or the 
termination of a reasonable time, any excess of the amount by which the 
gross assets was reduced over the amount of the liability shall be 
treated in the same manner as if such excess had been considered part of 
the net assets.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec. 1.507-8  Liability in case of transfers.

    For purposes of determining liability for the tax imposed under 
section 507(c) in the case of assets transferred by the private 
foundation, such tax shall be deemed to have been imposed on the first 
day on which action is taken by the organization which culminates in its 
ceasing to be a private foundation. If an organization's private 
foundation status is terminated under section 507(a)(2), the first day 
on which action is taken which culminates in its ceasing to be a private 
foundation (within

[[Page 106]]

the meaning of section 507(f)) shall be the date described in Sec. 
1.507-7(b)(2). If an organization terminates its private foundation 
status under section 507(a)(1), the first day on which action is taken 
which culminates in its ceasing to be a private foundation (within the 
meaning of section 507(f)) shall be the date described in Sec. 1.507-
7(b)(1).

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec. 1.507-9  Abatement of taxes.

    (a) General rule. The Commissioner may at his discretion abate the 
unpaid portion of the assessment of any tax imposed by section 507(c), 
or any liability in respect thereof, if:
    (1) The private foundation distributes all of its net assets to one 
or more organizations described in section 170(b)(1)(A) (other than in 
clauses (vii) or (viii)) each of which has been in existence and so 
described for a continuous period of at least 60 calendar months, or
    (2) Effective assurance is given to the Commissioner in accordance 
with paragraphs (b) and (c) of this section that the assets of the 
organization which are dedicated to charitable purposes will, in fact, 
be used for charitable purposes


The provisions of Sec. 1.507-2(a) (2), (3), and (7) shall apply to 
distributions under subparagraph (1) of this paragraph. Since section 
507(g) provides only for the abatement of tax imposed under section 
507(c), no tax imposed under any provision of chapter 42 shall be abated 
under section 507(g). Where the taxpayer files a petition with the Tax 
Court with respect to a notice of deficiency regarding any tax under 
section 507(c), such tax shall be treated as having been assessed for 
the purposes of abatement of such tax under section 507(g) and the 
regulations thereunder.
    (b) State proceedings. (1) The Commissioner may at his discretion 
abate the unpaid portion of the assessment of any tax imposed by section 
507(c), or any liability in respect thereof, under the procedures 
outlined in subparagraphs (2) and (3) of this paragraph. Such tax may 
not be abated by the Commissioner unless he determines that corrective 
action as defined in paragraph (c) of this section has been taken. The 
Commissioner may not abate by reason of section 507(g) any amount of 
such tax which has already been collected since only the unpaid portion 
thereof can be abated.
    (2) The appropriate State officer shall have 1 year from the date of 
notification prescribed in section 6104(c) that a notice of deficiency 
of tax imposed under section 507(c) has been issued with respect to a 
foundation, to advise the Commissioner that corrective action has been 
initiated pursuant to State law as may be ordered or approved by a court 
of competent jurisdiction. Corrective action may be initiated either by 
the appropriate State officer or by an organization described in section 
509(a) (1), (2), or (3) which is a beneficiary of the private foundation 
and has enforceable rights against such foundation under State law. 
Copies of all pleadings and other documents filed with the court at the 
initial stages of the proceedings shall be attached to the notification 
made by the State officer to the Commissioner. Prior to notification by 
the appropriate State officer that corrective action has been initiated, 
the Commissioner shall follow those procedures which would apply with 
respect to the assessment and collection of the tax imposed under 
section 507(c) without regard to section 507(g)(2). Subsequent to 
notification by the appropriate State officer that corrective action has 
been initiated, the Commissioner shall suspend action with respect to 
the assessment or collection of tax imposed under section 507(c) until 
notified of the final determination of such corrective action, as long 
as any such resulting delay does not jeopardize the collection of such 
tax and does not cause collection to be barred by operation of law or 
any rule of law. In any case where collection of such tax is about to be 
barred by operation of section 6502 and the Commissioner has not been 
advised of the final determination of corrective action, the 
Commissioner should make every effort to obtain appropriate agreements 
with the foundation subject to such tax to extend the period of 
limitations under section 6502(a)(2). Where such agreements are 
obtained, action with respect to the assessment and collection of such 
tax may be suspended to

[[Page 107]]

the extent not inconsistent with this subparagraph.
    (3) Upon receipt of certification from the appropriate State officer 
that action has been ordered or approved by a court of competent 
jurisdiction, the Commissioner may abate the unpaid portion of the 
assessment of tax imposed by section 507(c), or any liability in respect 
thereof, if in his judgment such action is corrective action within the 
meaning of paragraph (c) of this section. In the event that such action 
is not corrective action, the Commissioner may in his discretion again 
suspend action on the assessment and collection of such tax until 
corrective action is obtained, or if in his judgment corrective action 
cannot be obtained, he may resume the assessment and collection of such 
tax.
    (c) Corrective action. The term corrective action referred to in 
paragraph (b) of this section means vigorous enforcement of State laws 
sufficient to assure implementation of the provisions of chapter 42 and 
insure that the assets of such private foundation are preserved for such 
charitable or other purposes specified in section 501(c)(3). Except 
where assets of the terminated private foundation are transferred to an 
organization described in section 509(a) (1) through (4) the State is 
required to take such action to assure that the provisions of section 
508(e)(1) (A) and (B) are applicable to the terminated foundation (or 
any transferee) with respect to such assets as if such organization were 
a private foundation. Thus, the governing instrument of such 
organization must include provisions with respect to such assets:
    (1) Requiring its income therefrom for each taxable year to be 
distributed at such time and in such manner as not to subject such 
organization to tax under section 4942 (as if the organization were a 
private foundation),
    (2) Prohibiting such organization from engaging in any act of self-
dealing (as defined in section 4941(d) as if the organization were a 
private foundation),
    (3) Prohibiting such organization from retaining any excess business 
holdings (as defined in section 4943(c) as if the organization were a 
private foundation),
    (4) Prohibiting such organization from making any investments in 
such manner as to subject such organization to tax under section 4944 
(as if the organization were a private foundation), and
    (5) Prohibiting such organization from making any taxable 
expenditures (as defined in section 4945(d) as if the organization were 
a private foundation). Consequently, in cases where the preceding 
sentence applies, although the private foundation status of an 
organization is terminated for tax purposes, it is contemplated that its 
status under State law would remain unchanged, because the tax under 
section 507(c) has been abated solely because the Commissioner has been 
given effective assurance that there is vigorous enforcement of State 
laws sufficient to assure implementation of the provisions of chapter 
42. Therefore, in such a case while chapter 42 will not apply to acts 
occurring subsequent to termination which previously would have resulted 
in the imposition of tax under chapter 42, it is contemplated that there 
will be vigorous enforcement of State laws (including laws made 
applicable by the provisions in the governing instrument) with respect 
to such acts. Notwithstanding the preceding three sentences, no 
amendment to the organization's governing instrument is necessary where 
there are provisions of State law which have the effect of requiring a 
terminated private foundation to which the rules of subparagraphs (1) 
through (5) of this paragraph apply to be subject to such rules whether 
or not there are such provisions in such terminated private foundation's 
governing instrument.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec. 1.508-1  Notices.

    (a) New organizations must notify the Commissioner that they are 
applying for recognition of section 501(c)(3) status--(1) In general. 
Except as provided in subparagraph (3) of this paragraph, an 
organization that is organized after October 9, 1969, will not be 
treated as described in section 501(c)(3):
    (i) Unless such organization has given the Commissioner notice in 
the manner prescribed in subparagraph (2) of this paragraph; or

[[Page 108]]

    (ii) For any period before the giving of such notice, unless such 
notice is given in the manner and within the time prescribed in 
subparagraph (2) of this paragraph


No organization shall be exempt from taxation under section 501(a) by 
reason of being described in section 501(c)(3) whenever such 
organization is not treated as described in section 501(c)(3) by reason 
of section 508(a) and this paragraph. See section 508(d)(2)(B) and Sec. 
1.508-2(b) regarding the deductibility of charitable contributions to an 
organization during the period such organization is not exempt under 
section 501(a) as an organization described in section 501(c)(3) by 
reason of failing to file a notice under section 508(a) and this 
subparagraph. See also Sec. 1.508-2(b)(1)(viii) regarding the 
deductibility of charitable contributions to trusts described in section 
4947(a)(1).
    (2) Filing of notice. (i) For purposes of subparagraph (1) of this 
paragraph, except as provided in subparagraph (3) of this paragraph, an 
organization seeking exemption under section 501(c)(3) must file the 
notice described in section 508(a) within 15 months from the end of the 
month in which the organization was organized, or before March 22, 1973, 
whichever comes later. Such notice is filed by submitting a properly 
completed and executed Form 1023, exemption application. Notice should 
be filed with the district director. A request for extension of time for 
the filing of such notice should be submitted to such district director. 
Such request may be granted if it demonstrates that additional time is 
required.
    (ii) Although the information required by Form 1023 must be 
submitted to satisfy the notice required by this section, the failure to 
supply, within the required time, all of the information required to 
complete such form is not alone sufficient to deny exemption from the 
date of organization to the date such complete information is submitted 
by the organization. If the information which is submitted within the 
required time is incomplete, and the organization supplies the necessary 
additional information at the request of the Commissioner within the 
additional time period allowed by him, the original notice will be 
considered timely.
    (iii) For purposes of subdivision (i) of this subparagraph and 
paragraph (b)(2)(i) of this section, an organization shall be considered 
organized on the date it becomes an organization described in section 
501(c)(3) (determined without regard to section 508(a)).
    (iv) Since a trust described in section 4947(a)(2) is not an 
organization described in section 501(c)(3), it is not required to file 
a notice described in section 508(a).
    (v) For the treatment of community trusts, and the trusts or funds 
comprising them, under section 508, see the special rules under Sec. 
1.170A-9(e).
    (vi) A foreign organization shall, for purposes of section 508, be 
treated in the same manner as a domestic organization, except that 
section 508 shall not apply to a foreign organization which is described 
in section 4948(b).
    (3) Exceptions from notice. (i) Paragraphs (a) (1) and (2) of this 
section are inapplicable to the following organizations:
    (a) Churches, interchurch organizations of local units of a church, 
conventions or associations of churches, or integrated auxiliaries of a 
church. See Sec. 1.6033-2(h) regarding the definition of integrated 
auxiliary of a church;
    (b) Any organization which is not a private foundation (as defined 
in section 509(a)) and the gross receipts of which in each taxable year 
are normally not more than $5,000 (as described in subdivision (ii) of 
this subparagraph);
    (c) Subordinate organizations (other than private foundations) 
covered by a group exemption letter;
    (d) Solely for purposes of sections 507, 508(d)(1), 508(d)(2)(A) and 
508(d)(3), 508(e), 509 and chapter 42, a trust described in section 
4947(a)(1). (However, a trust described in section 501(c)(3) which was 
organized after October 9, 1969, shall be exempt under section 501(a) by 
reason of being described in section 501(c)(3) only if it files such 
notice); and
    (e) Any other class of organization that the Commissioner from time 
to time excludes from the requirement of filing notice under section 
508(a).

[[Page 109]]

    (ii) For purposes of subdivision (i) (b) of this subparagraph and 
paragraph (b)(7)(ii) of this section, the gross receipts (as defined in 
subdivision (iii) of this subparagraph) of an organization are normally 
not more than $5,000 if:
    (a) During the first taxable year of the organization the 
organization has received gross receipts of $7,500 or less;
    (b) During its first 2 taxable years the aggregate gross receipts 
received by the organization are $12,000 or less; and
    (c) In the case of an organization which has been in existence for 
at least 3 taxable years, the aggregate gross receipts received by the 
organization during the immediately preceding 2 taxable years, plus the 
current year are $15,000 or less


If an organization fails to meet the requirements of (a), (b), or (c) of 
this subdivision, then with respect to the organization, such 
organization shall be required to file the notices described in section 
508 (a) and (b) within 90 days after the end of the period described in 
(a), (b), or (c) of this subdivision or before March 22, 1973, whichever 
is later, in lieu of the period prescribed in subparagraph (2)(i) of 
this paragraph. Thus, for example, if an organization meets the $7,500 
requirement of (a) of this subdivision for its first taxable year, but 
fails to meet the $12,000 requirement of (b) of this subdivision for the 
period ending with its second taxable year, then such organization shall 
meet the notification requirements of section 508(a)(1) and 508(b) and 
subparagraph (2)(i) of this paragraph if it files such notification 
within 90 days after the close of its second taxable year. If an 
organization which has been in existence at least 3 taxable years meets 
the requirements of (a), (b), and (c) with respect to all prior taxable 
years, but fails to meet the requirements of (c) of this subdivision 
with respect to the current taxable year, then even if the organization 
fails to make such notification within 90 days after the close of the 
current taxable year, section 508(a)(1) and 508(b) shall not apply with 
respect to its prior years. In such a case, the organization shall not 
be treated as described in section 501(c)(3) for a period beginning with 
such current taxable year and ending when such notice is given under 
section 508(a)(2).
    (iii) For a definition of gross receipts for purposes of subdivision 
(i)(b) of this subparagraph and paragraph (b)(7)(ii) of this section, 
see Sec. 1.6033-2(g)(4).
    (4) Voluntary filings by new organizations excepted from filing 
notice. Any organization excepted from the requirement of filing notice 
under section 508(a) will be exempt from taxation under section 
501(c)(3) if it meets the requirements of that section, whether or not 
it files such notice. However, in order to establish its exemption with 
the Internal Revenue Service and receive a ruling or determination 
letter recognizing its exempt status, an organization excepted from the 
notice requirement by reason of subparagraph (3) of this paragraph 
should file proof of its exemption in the manner prescribed in Sec. 
1.501(a)-1.
    (b) Presumption that old and new organizations are private 
foundations--(1) In general. Except as provided in subparagraph (7) of 
this paragraph, any organization (including an organization in existence 
on October 9, 1969) which is described in section 501(c)(3), and which 
does not notify the Commissioner within the time and in the manner 
prescribed in subparagraph (2) that it is not a private foundation, will 
be presumed to be a private foundation.
    (2) Filing of notice. (i) Except as provided in subparagraph (7) of 
this paragraph, an organization must file the notice described in 
section 508(b) and subparagraph (1) of this paragraph within 15 months 
from the end of the month in which such organization was organized, or 
before March 22, 1973, whichever comes later. See paragraph (a)(2)(iii) 
of this section, for rules pertaining to when an organization is 
organized.
    (ii) Any organization filing notice under this paragraph that has 
received a ruling or determination letter from the Internal Revenue 
Service dated on or before July 13, 1970, recognizing its exemption from 
taxation under section 501(c)(3) (or the corresponding provisions of 
prior law), shall file the notice described in section 508(b) by 
submitting a properly completed and executed Form 4653, Notification 
Concerning Foundation Status.

[[Page 110]]

    (iii) The financial schedule on Form 4653 need be completed only if 
the organization is, or thinks it might be, described in section 
170(b)(1)(A) (iv) or (vi) or section 509(a)(2).
    (iv) Any organization filing notice under this paragraph that has 
not received a ruling or determination letter from the Internal Revenue 
Service dated on or before July 13, 1970, recognizing its exemption from 
taxation under section 501(c)(3) (or the corresponding provisions of 
prior law), shall file its notice by submitting a properly completed and 
executed Form 1023 and providing information that it is not a private 
foundation. The organization shall also submit all information required 
by the regulations under section 170 or 509 (whichever is applicable) 
necessary to establish recognition of its classification as an 
organization described in section 509(a) (1), (2), (3), or (4). A Form 
1023 submitted prior to July 14, 1970, will satisfy this requirement if 
the organization submits an additional statement that it is not a 
private foundation together with all pertinent additional information 
required. Any statement filed under this subdivision shall be 
accompanied by a written declaration by the principal officer, manager 
or authorized trustee that there is a reasonable basis in law and in 
fact for the statement that the organization so filing is not a private 
foundation, and that to the best of the knowledge and belief of such 
officer, manager or trustee, the information submitted is complete and 
correct.
    (v) The notice filed under subdivision (ii) of this subparagraph 
should be filed in accordance with the instructions applicable to Form 
4653. The notice required by subdivision (iv) of this subparagraph 
should be filed with the district director. An extension of time for the 
filing of such notice may be granted by the Director of the Internal 
Revenue Service Center or district director upon timely request by the 
organization to such person, if the organization demonstrates that 
additional time is required.
    (3) Effect of notice upon the filing organization. (i) The notice 
filed under this paragraph may not be relied upon by the organization so 
filing unless and until the Internal Revenue Service notifies the 
organization that it is an organization described in paragraph (1), (2), 
(3), or (4), of section 509(a). For purposes of the preceding sentence, 
an organization that has filed notice under section 508(b), and has 
previously received a ruling that it is an organization described in 
section 170(b)(1)(A) (other than clauses (vii) and (viii) thereof), will 
be considered to have been notified by the Internal Revenue Service that 
it is an organization described in paragraph (1) of section 509(a) if 
(a) the facts and circumstances forming the basis for the issuance of 
such ruling have not substantially changed, and (b) the ruling issued 
under that section has not been revoked expressly or by a subsequent 
change of the law or regulations under which the ruling was issued.
    (ii) If an organization has filed a notice under section 508(b) 
stating that it is not a private foundation and designating only one 
paragraph of section 509(a) under which it claims recognition of its 
classification (such as an organization described in section 509(a)(2)), 
and if it has received a ruling or determination letter which recognizes 
that it is not a private foundation but which fails to designate the 
paragraph under section 509(a) in which it is described, then such 
organization will be treated as described under the paragraph designated 
by it, until such ruling or determination letter is modified or revoked. 
The rule in the preceding sentence shall not apply to an organization 
which indicated that it does not know its status under section 509(a) or 
which claimed recognition of its status under more than one paragraph of 
section 509(a).
    (4) Effect of notice upon grantors or contributors to the filing 
organization. In the case of grants, contributions, or distributions 
made prior to:
    (i) In the case of community trusts, 6 months after the date on 
which corrective and clarifying regulations designated as Sec. 1.170A-
9(e)(10) become final;
    (ii) In the case of medical research organizations, 6 months after 
the date on which corrective and clarifying regulations designated as 
Sec. 1.170A-9(b)(2), become final, and

[[Page 111]]

    (iii) In all other cases, January 1, 1976, any organization which 
has properly filed the notice described in section 508(b) prior to March 
22, 1973 will not be treated as a private foundation for purposes of 
making any determination under the internal revenue laws with respect to 
a grantor, contributor or distributor (as for example, a private 
foundation distributing all of its net assets pursuant to a section 
507(b)(1)(A) termination) thereto, unless the organization is controlled 
directly or indirectly by such grantor, contributor or distributor, if 
by the 30th day after the day on which such notice is filed, the 
organization has not been notified by the Commissioner that the notice 
filed by such organization has failed to establish that such 
organization is not a private foundation. See subparagraph (6) of this 
paragraph for the effect of an adverse notice by the Internal Revenue 
Service. For purposes of this subparagraph, an organization which has 
properly filed notice described in section 508(b) prior to March 22, 
1973, and which has claimed recognition of its status under only one 
paragraph of section 509(a) in such notice, will be treated only for 
purposes of grantors, contributors or distributors as having the 
classification claimed in the notice if the provisions of this 
subparagraph are otherwise satisfied.
    (5) Statement that old and new organizations are operating 
foundations. (i) Any organization (including an organization in 
existence on October 9, 1969) which is described in section 501(c)(3) 
may submit a statement, in the form and manner provided for notice in 
subparagraph (2) of this paragraph, that it is an operating foundation 
(as defined in section 4942(j)(3)) and include in such statement:
    (a) Necessary supporting information as required by the regulations 
under section 4942(j)(3) to confirm such determination (including a 
statement identifying the clause of section 4942(j)(3)(B) that is 
applicable); and
    (b) A written declaration by the principal officer, manager, or 
authorized trustee that there is a reasonable basis in law and in fact 
that the organization so filing is an operating foundation, and that to 
the best of the knowledge and belief of such officer, manager or 
trustee, the information submitted is complete and correct.
    (ii) The statement filed under this subparagraph may not be relied 
upon by the organization so filing unless and until the Internal Revenue 
Service notifies the organization that it is an operating foundation 
described in section 4942(j)(3).
    (iii) In the case of grants, contributions, or distributions made 
prior to March 22, 1973, any organization which has properly filed the 
statement described in this subparagraph prior to such date will be 
treated as an operating foundation for purposes of making any 
determination under the internal revenue laws with respect to a grantor, 
contributor, or distributor thereto, unless the organization is 
controlled directly or indirectly by such grantor, contributor, or 
distributor, if by the 30th day after the day on which such statement is 
filed, the organization has not been notified by the Commissioner or his 
delegate that its statement has failed to establish that such 
organization is an operating foundation. See subparagraph (6) of this 
paragraph for the effect of an adverse notice by the Internal Revenue 
Service.
    (6) Effect of notice by Internal Revenue Service concerning 
organization's notice or statement. Subparagraph (4) and subdivision 
(iii) of subparagrph (5) of this paragraph shall have no effect:
    (i) With respect to a grantor, contributor, or distributor to any 
organization for any period after the date on which the Internal Revenue 
Service makes notice to the public (such as by publication in the 
Internal Revenue Bulletin) that a grantor, contributor, or distributor 
to such organization can no longer rely upon the notice or statement 
submitted by such organization; and
    (ii) Upon any grant, contribution, or distribution made to an 
organization on or after the date on which a grantor, contributor, or 
distributor acquired knowledge that the Internal Revenue Service has 
given notice to such organization that its notice or statement has 
failed to establish that such organization either is not a private 
foundation, or is an operating foundation, as the case may be.

[[Page 112]]

    (7) Exceptions from notice. Subparagraphs (1) and (2) of this 
paragraph are inapplicable to the following organizations:
    (i) Churches, interchurch organizations of local units of a church, 
conventions or associations of churches, or integrated auxiliaries of a 
church, such as a men's or women's organization, religious school, 
mission society, or youth group;
    (ii) Any organization which is not a private foundation (as defined 
in section 509(a)) and the gross receipts of which in each taxable year 
are normally not more than $5,000 (as determined under paragraph 
(a)(3)(ii) of this section);
    (iii) Subordinate organizations (other than private foundations) 
covered by a group exemption letter but only if the parent or 
supervisory organization submits a notice covering the subordinates;
    (iv) Trusts described in section 4947(a)(1); and
    (v) Any other class of organization that the Commissioner from time 
to time excludes from the notification requirements of section 508(b).
    (8) Voluntary filings by organizations excepted from filing notice. 
Any organization excepted from the requirement of filing notice under 
section 508(b) by reason of subdivisions (i), (ii), and (v) of 
subparagraph (7) of this paragraph may receive the benefits of 
subparagraph (4) of this paragraph by filing such notice.

(Secs. 508 and 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 
26 U.S.C. 7805))

[T.D. 7232, 37 FR 28289, Dec. 22, 1972, as amended by T.D. 7342, 40 FR 
1237, Jan. 7, 1975; T.D. 7395, 41 FR 1063, Jan. 6, 1976; T.D. 8640, 60 
FR 65552, Dec. 20, 1995]



Sec. 1.508-2  Disallowance of certain charitable, etc., deductions.

    (a) Gift or bequest to organizations subject to section 507(c) tax--
(1) General rule. No gift or bequest made to an organization upon which 
the tax provided by section 507(c) has been imposed shall be allowed as 
a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522, if such gift or bequest is made:
    (i) By any person after notification has been made by the 
organization under section 507(a)(1) or after notification has been made 
by the Commissioner under section 507(a)(2)(B), or
    (ii) By a substantial contributor (as defined in section 507(d)(2)) 
in his taxable year which includes the first day on which action is 
taken by such organization which culminates in the imposition of tax 
under section 507(c) and any subsequent taxable year


For purposes of subdivision (ii) of this subparagraph, the first day on 
which action is taken by an organization which culminates in the 
imposition of tax under section 507(c) shall be determined under the 
rules set forth in Sec. 1.507-7(b) (1) and (2).
    (2) Exception. Subparagraph (1) of this paragraph shall not apply if 
the entire amount of the unpaid portion of the tax imposed by section 
507(c) is abated by the Commissioner under section 507(g).
    (b) Gift or bequest to taxable private foundation, section 4947 
trust, etc.--(1) General rule. (i) Except as provided in subparagraph 
(2) of this paragraph, no gift or bequest made to an organization shall 
be allowed as a deduction under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522, if such gift or bequest is made:
    (a) To a private foundation or a trust described in section 
4947(a)(2) in a taxable year for which it fails to meet the requirements 
of section 508(e) (determined without regard to section 508(e)(2) (B) 
and (C), or
    (b) To any organization in a period for which it is not treated as 
an organization described in section 501(c)(3) by reason of section 
508(a).
    (ii) For purposes of subdivision (i)(a) of this subparagraph the 
term taxable year refers to the taxable year of the donee or beneficiary 
organization. In the event a bequest is made to a private foundation or 
trust described in section 4947(a)(2) which is not in existence at the 
date of the testator's death (but which is created under the terms of 
the testator's will), the term taxable year shall mean the first taxable 
year of the private foundation or trust.
    (iii) For purposes of subdivision (i)(a) of this subparagraph, an 
organization does not fail to meet the requirements of section 508(e) 
for a taxable year, unless it fails to meet such requirements

[[Page 113]]

for the entire year. Therefore, even if a donee organization fails to 
meet the requirements of section 508(e) on the date it receives a grant 
from a donor, the donor's grant will not be disallowed by operation of 
section 508(d)(2)(A) and subdivision (i)(a) of this subparagraph, if the 
organization meets the requirements of section 508(e) (determined 
without regard to section 508(e)(2) (B) or (C) ) by the end of its 
taxable year.
    (iv) No deduction will be disallowed under section 508(d)(2)(A) with 
respect to a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 if during the taxable year in question, the 
private foundation or trust described in section 4947(a)(2) has 
instituted a judicial proceeding which is necessary to reform its 
governing instrument or other instrument in order to meet the 
requirements of section 508(e)(1). This subdivision shall not apply 
unless within a reasonable time such judicial proceedings succeed in so 
reforming such instrument.
    (v) No deduction will be disallowed under section 508(d)(2)(A) and 
subdivision (i)(a) of this subparagraph for any taxable year beginning 
before January 1, 1972, with respect to a private foundation or trust 
described in section 4947 organized before January 1, 1970. See also 
Sec. 1.508-3(g) regarding transitional rules for extending compliance 
with section 508(e)(1).
    (vi)(a) In the case of a contribution or bequest to a trust 
described in section 4947(a)(2) other than to a trust to which 
subdivision (vii) of this subparagraph applies, no deduction shall be 
disallowed by reason of section 508(d)(2)(A) on the grounds that such 
trust's governing instrument contains no provisions with respect to 
section 4942. Similarly, if for a taxable year such trust is also a 
trust described in section 4947(b)(3), no deduction for such year shall 
be so disallowed on the grounds that the governing instrument contains 
no provision with respect to section 4943 or 4944.
    (b) This subdivision may be illustrated by the following example:

    Example. H executes a will on January 1, 1977, establishing a 
charitable remainder trust (as described in section 664) with income 
payable to W, his wife, for life, remainder to X university, an 
organization described in section 170(b)(1)(A)(ii). The will provides 
that the trust is prohibited from engaging in activities which would 
subject itself, its foundation manager or a disqualified person to taxes 
under section 4941 or 4945 of the Code. The will is silent as to 
sections 4942, 4943, and 4944. H dies February 12, 1978. Section 
508(d)(2)(A) will not operate to disallow any deduction to H's estate 
under section 2055 with respect to such trust.

    (vii)(a) In the case of a trust described in section 4947(a)(2) 
which by its terms will become a trust described in section 4947(a)(1) 
and the governing instrument of which is executed after March 22, 1973, 
the governing instrument shall not meet the requirements of section 
508(e)(1) if it does not contain provisions to the effect that the trust 
must comply with the provisions of section 4942, or sections 4942, 4943, 
and 4944 (as the case may be) to the extent such section or sections 
shall become applicable to such trust.
    (b) This subdivision may be illustrated by the following example:

    Example. H executes a will on January 1, 1977, establishing a 
charitable remainder trust (as described in section 664) with income 
payable to W, his wife, for life, remainder in trust in perpetuity for 
the benefit of an organization described in section 170(c). By its terms 
the trust will become a trust described in section 4947(a)(1), and will 
become a private foundation. The will provides that the trust is 
prohibited from engaging in activities which would subject itself, its 
foundation manager or a disqualified person to taxes under sections 4941 
or 4945 of the Code. The will is silent as to sections 4942, 4943, and 
4944. H dies February 12, 1978. Unless the trust's governing instrument 
is amended prior to the end of the trust's first taxable year, or 
judicial proceedings have been instituted under subdivision (iv) of this 
subparagraph, section 508(d)(2)(A) will operate to disallow any 
deduction to H's estate under section 2055 with respect to such trust.

    (viii) Since a charitable trust described in section 4947(a)(1) is 
not required to file a notice under section 508(a), section 508(d)(2)(B) 
and subdivision (i)(b) of this subparagraph are not applicable to such a 
trust.
    (2) Transitional rules. Any deduction which would otherwise be 
allowable under section 642(c)(2), 2106(a)(2), or 2055 shall not be 
disallowed under section 508(d)(2)(A) if such deduction is attributable 
to:

[[Page 114]]

    (i) Property passing under the terms of a will executed on or before 
October 9, 1969,
    (a) If the decedent dies after October 9, 1969, but before October 
9, 1972, without having amended any dispositive provision of the will 
after October 9, 1969, by codicil or otherwise,
    (b) If the decedent dies after October 9, 1969, and at no time after 
that date had the right to change the portions of the will which 
pertains to the passing of property to, or for the use of, an 
organization described in section 170(c)(2)(B) or 2055(a), or
    (c) If no dispositive provision of the will is amended by the 
decedent, by codicil or otherwise, before October 9, 1972, and the 
decedent is on October 9, 1972, 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, or
    (ii) Property transferred in trust on or before October 9, 1969,
    (a) If the grantor dies after October 9, 1969, but before October 9, 
1972, without having amended, after October 9, 1969, any dispositive 
provision of the instrument governing the disposition of the property,
    (b) If the property transferred was an irrevocable interest to, or 
for the use of, an organization described in section 170(c)(2)(B) or 
2055(a),
    (c) In the case of a deduction under section 2106(a)(2) or 2055; if 
no dispositive provision of the instrument governing the disposition of 
the property is amended by the grantor before October 9, 1972, and the 
grantor is on October 9, 1972, and at all times thereafter under a 
mental disability (as defined in Sec. 1.642(c)-2(b)(3)(ii)) to change 
the disposition of the property, or
    (d) In the case of a deduction under section 642(c)(2)(A), if the 
grantor is at all times after October 9, 1969, and up to, and including, 
the last day of the taxable year for which the deduction under such 
section is claimed, under a mental disability (as defined in Sec. 
1.642(c)-2(b)(3)(ii)) to change the terms of the trust


See also Sec. 1.508-3(g) regarding the extension of time for compliance 
with section 508(e), Sec. 1.664-1(f)(3) (ii) and (g) regarding the 
special transitional rules for charitable remainder annuity and 
unitrusts described in section 664 which were created prior to December 
31, 1972, and Sec. 20.2055-2(e)(4) of this chapter regarding the rules 
for determining if the dispositive provisions have been amended.

[T.D. 7232, 37 FR 28291, Dec. 22, 1972]



Sec. 1.508-3  Governing instruments.

    (a) General rule. A private foundation shall not be exempt from 
taxation under section 501(a) for a taxable year unless by the end of 
such taxable year its governing instrument includes provisions the 
effects of which are:
    (1) To require distributions at such times and in such manner as not 
to subject the foundation to tax under section 4942, and
    (2) To prohibit the foundation from engaging in any act of self-
dealing (as defined in section 4941(d)), from retaining any excess 
business holdings (as defined in section 4943(c)), from making any 
investments in such manner as to subject the foundation to tax under 
section 4944, and from making any taxable expenditures (as defined in 
section 4945(d)).
    (b) Effect and nature of governing instrument--(1) In general. 
Except as provided in paragraph (d) of this section, the provisions of a 
foundation's governing instrument must require or prohibit, as the case 
may be, the foundation to act or refrain from acting so that the 
foundation, and any foundation managers or other disqualified persons 
with respect thereto, shall not be liable for any of the taxes imposed 
by sections 4941, 4942, 4943, 4944, and 4945 of the Code or, in the case 
of a split-interest trust described in section 4947(a)(2), any of the 
taxes imposed by those sections of chapter 42 made applicable under 
section 4947. Specific reference to these sections of the Code will 
generally be required to be included in the governing instrument, unless 
equivalent language is used which is deemed by the Commissioner to have 
the same full force and effect. However, a governing instrument which 
contains only language sufficient to satisfy the requirements of the 
organizational test under Sec. 1.501(c)(3)-1(b) will not be considered 
as meeting the requirements of this subparagraph, regardless of the 
interpretation placed

[[Page 115]]

on such language as a matter of law by a State court in a particular 
jurisdiction, unless the requirements of paragraph (d) of this section 
are satisfied.
    (2) Corpus. A governing instrument does not meet the requirements of 
paragraph (a)(1) of this section if it expressly prohibits the 
distribution of capital or corpus.
    (3) Savings provisions. For purposes of sections 508(d)(2) (A) and 
(e), a governing instrument need not include any provision which is 
inconsistent with section 101(l) (2), (3), (4), or (5) of the Tax Reform 
Act of 1969 (83 Stat. 533), as amended by sections 1301 and 1309 of the 
Tax Reform Act of 1976 (90 Stat. 1713, 1729), with respect to the 
organization. Accordingly, a governing instrument complying with the 
requirements of subparagraph (1) of this paragraph may incorporate any 
savings provision contained in section 101(l) (2), (3), (4), or (5) of 
the Tax Reform Act of 1969, as amended by sections 1301 and 1309 of the 
Tax Reform Act of 1976, as a specific exception to the general 
provisions of paragraph (a) of this section. In addition, in the absence 
of any express provisions to the contrary, the exceptions contained in 
such savings provisions will generally be regarded as contained in a 
governing instrument meeting the requirements of subparagraph (1) of 
this paragraph.
    (4) Excess holdings. For purposes of paragraph (a)(2) of this 
section, the prohibition against retaining any excess business holdings 
(as defined in section 4943(c)) shall be deemed only to prohibit the 
foundation from retaining any excess business holdings when such 
holdings would subject the foundation to tax under section 4943(a).
    (5) Revoked ruling on status. In the case of an organization which:
    (i) Has been classified as an organization described in section 
509(a) (1), (2), (3), or (4), and
    (ii) Subsequently receives a ruling or determination letter stating 
that it is no longer described in section 509(a) (1), (2), (3), or (4), 
but is a private foundation within the meaning of section 509,

such organization shall have 1 year from the date of receipt of such 
ruling or determination letter, or the final ruling or determination 
letter if a protest is filed to an earlier one, to meet the requirements 
of section 508(e). Section 508(d)(2)(A) shall not be applicable with 
respect to gifts and bequests made during this 1-year period if such 
requirements are met within the 1-year period.
    (6) Judicial proceeding. For purposes of paragraphs (a), (b)(5), 
(d)(2), and (e)(3) of this section, an organization shall be deemed to 
have met the requirements of section 508(e) within a year, if a judicial 
proceeding which is necessary to reform its governing instrument or 
other instrument is instituted within the year and within a reasonable 
time the organization, in fact, meets the requirements of section 
508(e). For purposes only of paragraphs (b)(5), (d)(2), and (e)(3) of 
this section, if an organization organized before January 1, 1970, 
institutes such a judicial proceeding within such 1-year period, section 
508 (e)(2)(C) shall be applied as if such proceeding had been instituted 
prior to January 1, 1972.
    (c) Meaning of governing instrument. For purposes of section 508(e), 
the term governing instrument shall have the same meaning as the term 
articles of organization under Sec. 1.501(c)(3)-1(b)(2). The bylaws of 
an organization shall not constitute its governing instrument for 
purposes of section 508(e).
    (d) Effect of State law--(1) In general. A private foundation's 
governing instrument shall be deemed to conform with the requirements of 
paragraph (a) of this section if valid provisions of State law have been 
enacted which:
    (i) Require it to act or refrain from acting so as not to subject 
the foundation to the taxes imposed by section 4941 (relating to taxes 
on self-dealing), 4942 (relating to taxes on failure to distribute 
income), 4943 (relating to taxes on excess business holdings), 4944 
(relating to taxes on investments which jeopardize charitable purpose), 
and 4945 (relating to taxable expenditures); or
    (ii) Treat the required provisions as contained in the foundation's 
governing instrument.
    (2) Validity. (i) Any provision of State law described in 
subparagraph (1) of this paragraph shall be presumed valid as enacted, 
and in the absence of State provisions to the contrary, to apply with 
respect to any foundation that does not specifically disclaim coverage

[[Page 116]]

under State law (either by notification to the appropriate State 
official or by commencement of judicial proceedings) except as provided 
in subdivisions (ii) and (iii) of this subparagraph.
    (ii) If such provision is declared invalid or inapplicable with 
respect to a class of foundations by the highest appellate court of the 
State or by the Supreme Court of the United States, the foundations 
covered by the determination must meet the requirements of section 
508(e) within 1 year from the date on which the time for perfecting an 
application for review by the Supreme Court expires. If such application 
is filed, the requirements of section 508(e) must be met within a year 
from the date on which the Supreme Court disposes of the case, whether 
by denial of the application for review or decision on the merits.
    (iii) In addition, if such provision of State law is declared 
invalid or inapplicable with respect to a class of foundations by any 
court of competent jurisdiction which decision is not reviewed by a 
court referred to in subdivision (ii) of this subparagraph, and the 
Commissioner makes notice to the general public (such as by publication 
in the Internal Revenue Bulletin) that such provision has been so 
declared invalid or inapplicable, then all foundations in such State 
must meet the requirements of section 508(e), without reliance upon such 
statute to the extent declared invalid or inapplicable by such decision, 
within 1 year from the date such notice is made public.
    (iv) This subparagraph shall not apply to any foundation that is 
subject to a final judgment entered by a court of competent 
jurisdiction, holding the law invalid or inapplicable with respect to 
such foundation. See paragraph (b)(6) of this section for the effect of 
certain judicial proceedings that are brought within 1 year.
    (3) Conflicting instrument. For taxable years beginning after March 
22, 1973 in order for a private foundation or trust described in section 
4947(a)(2) to receive the benefit of coverage under any State statute 
which makes applicable the requirements of section 508(e)(1) (A) and 
(B), where the statute by its terms does not apply to a governing 
instrument which contains a mandatory direction conflicting with any of 
such requirements, such organization must indicate on its annual return 
required to be filed under section 6033 (or section 6012 in the case of 
a trust described in section 4947(a)) that its governing instrument 
contains no mandatory directions which conflict with the requirements of 
section 508(e)(1) (A) or (B), as incorporated by the State statute. 
General language in a governing instrument empowering the trustee to 
make investments without being limited to those investments authorized 
by law will not be regarded as a mandatory conflicting direction.
    (4) Exclusion from statute. (i) For any taxable year beginning after 
March 22, 1973 in the case of a private foundation or trust described in 
section 4947(a)(2) subject to a State statute which makes applicable the 
requirements of section 508(e)(1) (A) and (B) to the governing 
instruments of such organizations, other than those which take action to 
be excluded therefrom (such as by filing a notice of exclusion or by 
instituting appropriate judicial proceedings), an organization will 
receive the benefit of such State statute only if it indicates on its 
annual return required to be filed under section 6033 (or section 6012 
in the case of a trust described in section 4947(a)) that it has not so 
taken action to be excluded.
    (ii) This paragraph permits certain organizations that are subject 
to the provisions of such a State law, to avoid changing their governing 
instruments in order to meet the requirements of section 508(e)(1). 
Since an organization which avoids the application of a provision or 
provisions of State law, such as by filing a notice of exclusion, is not 
entitled to the benefits of this paragraph, such an organization must 
meet the requirements of section 508(e)(1) without regard to this 
paragraph and except as provided in section 508(e)(2)(C) or paragraph 
(g)(1)(iii) of this section must change its governing instrument to the 
extent inconsistent with section 508(e)(1).
    (5) Treatment of prevailing conflicting clause. If provisions of 
State law are inapplicable to a clause in a governing instrument which 
is contrary to the provisions of section 508(e)(1), the requirements of 
section 508(e)(2)(C) and

[[Page 117]]

paragraph (g)(1)(iii) of this section are not satisfied by a provision 
of State law which purports to eliminate the need for litigation under 
such circumstances. Therefore, except as otherwise provided in this 
section unless the governing instrument is changed or litigation is 
commenced pursuant to section 508(e)(2)(B) by an organization organized 
before January 1, 1970, or pursuant to paragraph (g)(1)(ii) of this 
section, to amend the nonconforming provision to meet the requirements 
of section 508(e)(1) (A) and (B), then pursuant to section 508(e), such 
organization will not be exempt from taxation.
    (6) Retroactive application to grants or bequests. If valid 
provisions of such a State law apply retroactively to a taxable year 
within which an organization has received a grant or request, section 
508(d)(2)(A) shall not apply so as to disallow such grant or bequest, 
but only if such valid provisions of State law are enacted within 2 
years of such grant or bequest.
    (e) Effect of section 508(e) upon section 4947 trusts--(1) Section 
4947(a)(1) trusts. A charitable trust described in section 4947(a)(1) 
(unless also described in a paragraph of section 509(a)) is subject to 
all the provisions of paragraph (a) of this section.
    (2) Section 4947(a)(2) trusts. A split-interest trust described in 
section 4947(a)(2), as long as it is so described, is subject to the 
provisions of paragraph (a)(2) of this section, except to the extent 
that section 4947 makes any such provisions inapplicable to certain 
trusts and certain amounts in trust. The governing instrument of a trust 
described in section 4947(a)(2) may except amounts described in section 
4947(a)(2) (A), (B), and (C) from the requirements of paragraph (a)(2) 
of this section. In the case of a trust having amounts transferred to it 
both before May 27, 1969, and after May 26, 1969, its governing 
instrument may except from the provisions of paragraph (a)(2) of this 
section only those segregated amounts excluded from the application of 
section 4947(a)(2) by reason of section 4947(a)(2)(C) and the 
regulations thereunder. Also, the governing instrument of such a trust 
may exclude the application of sections 4943 and 4944 for any period 
during which such trust is described in section 4947(b)(3) (A) or (B). 
See Sec. 53.4947-1(c) of this chapter for rules relating to the 
applicability of section 4947 to split-interest trusts and Sec. 1.508-
2(b)(1) (vi) and (vii) for rules relating to the deductibility of grants 
or bequests to such trusts.
    (3) A section 4947(a)(2) trust becoming a section 4947(a)(1) trust. 
If the governing instrument of a trust described in section 4947(a)(2) 
meets the applicable requirements of paragraph (a)(2) of this section 
and such trust ceases to be so described and becomes instead a trust 
described in section 4947(a)(1), then such governing instrument must 
meet, prior to the end of 12 months from the date such trust first 
becomes described in section 4947(a)(1) (except as otherwise provided in 
this section) all the requirements of paragraph (a) of this section in 
order to comply with section 508(e).
    (f) Special rules for existing private foundations. (1) Pursuant to 
section 508(e)(2), section 508(e)(1) and paragraph (a) of this section 
shall not apply in the case of any organization whose governing 
instrument was executed before January 1, 1970:
    (i) To any taxable year beginning before January 1, 1972;
    (ii) To any period after December 31, 1971, during the pendency of 
any judicial proceeding begun before January 1, 1972, by the private 
foundation which is necessary to reform, or to excuse such foundation 
from compliance with, its governing instrument or any other instrument 
in order to meet the requirements of section 508(e)(1); and
    (iii) To any period after the termination of any judicial proceeding 
described in subdivision (ii) of this subparagraph during which its 
governing instrument or any other instrument does not permit it to meet 
the requirements of section 508(e)(1).
    (2) For purposes of subparagraph (1) of this paragraph, and Sec. 
1.508-2(b)(1)(vi)(a), a governing instrument will not be treated as 
executed before the applicable date, if, after such date the dispositive 
provisions of the instrument are amended (determined under rules similar 
to the rules set forth in Sec. 20.2055-2(e)(4) of this chapter).
    (3) For purposes of subparagraph (1) (ii) and (iii) of this 
paragraph, a private

[[Page 118]]

foundation will be treated as meeting the requirements of section 
508(e)(2) (B) and (C) if it has commenced a necessary and timely 
proceeding in an appropriate court of original jurisdiction and such 
court has ruled that the foundation's governing instrument or any other 
instrument does not permit it to meet the requirements of section 
508(e)(1). Such foundation is not required to commence proceedings in 
any court of appellate jurisdiction in order to comply with section 
508(e)(2)(C). See also Sec. 1.508-2(b)(2).
    (g) Extension of time for compliance with section 508(e). (1) Except 
as provided in subparagraph (2) of this paragraph, section 508(e)(1) 
shall not apply to any private foundation (regardless of when organized) 
with respect:
    (i) To any taxable year beginning before the transitional date,
    (ii) To any period on or after the transitional date during the 
pendency of any judicial proceeding begun before the transitional date 
by the private foundation which is necessary to reform, or to excuse 
such foundation from compliance with, its governing instrument or any 
other instrument in order to meet the requirements of section 508(e)(1), 
and
    (iii) To any period after the termination of any judicial proceeding 
described in subdivision (ii) of this subparagraph during which its 
governing instrument or any other instrument does not permit it to meet 
the requirements of section 508(e)(1).
    (2) Subparagraph (1) of this paragraph shall apply only to gifts or 
bequests referred to in section 508(d)(2)(A) that are made before the 
transitional date.
    (3) For purposes of this paragraph the term transitional dates means 
the earlier of the following dates:
    (i) In the case of a medical research organization, May 21, 1976 or 
in the case of a community trust February 10, 1977, or
    (ii) The 91st day after the date an organization receives a final 
ruling or determination letter that it is a private foundation under 
section 509(a).

[T.D. 7232, 37 FR 28292, Dec. 22, 1972, as amended by T.D. 7440, 41 FR 
50656, Nov. 17, 1976; T.D. 7678, 45 FR 12415, Feb. 26, 1980]



Sec. 1.508-4  Effective date.

    Except as otherwise provided, Sec. Sec. 1.508-1 through 1.508-3 
shall take effect on January 1, 1970.

(Sec. 7805 of the Internal Revenue Code of 1954, 68A Stat. 917; 26 
U.S.C. 7805)

[T.D. 7232, 37 FR 28294, Dec. 22, 1972]



Sec. 1.509(a)-1  Definition of private foundation.

    In general. Section 509(a) defines the term private foundation to 
mean any domestic or foreign organization described in section 501(c)(3) 
other than an organization described in section 509(a) (1), (2), (3), or 
(4). Organizations which fall into the categories excluded from the 
definition of private foundation are generally those which either have 
broad public support or actively function in a supporting relationship 
to such organizations. Organizations which test for public safety are 
also excluded.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972]



Sec. 1.509(a)-2  Exclusion for certain organizations described in section 

170(b)(1)(A).

    (a) General rule. Organizations described in section 170(b)(1)(A) 
(other than in clauses (vii) and (viii)) are excluded from the 
definition of private foundation by section 509(a)(1). For the 
requirements to be met by organizations described in section 
170(b)(1)(A) (i) through (vi), see Sec. 1.170A-9 (a) through (e) and 
paragraph (b) of this section. For purposes of this section, the 
parenthetical language other than in clauses (vii) and (viii) used in 
section 509(a)(1) means other than an organization which is described 
only in clause (vii) or (viii). For purposes of this section, an 
organization may qualify as a section 509(a)(1) organization regardless 
of the fact that it does not satisfy section 170(c)(2) because:
    (1) Its funds are not used within the United States or its 
possessions, or
    (2) It was created or organized other than in, or under the law of, 
the United States, any State or territory, the District of Columbia, or 
any possession of the United States.
    (b) Medical research organizations. In order to qualify under 
section 509(a)(1)

[[Page 119]]

as a medical research organization described in section 
170(b)(1)(A)(iii), an organization must meet the requirements of section 
170(b)(1)(A)(iii) and Sec. 1.170A-9(c)(2), except that, solely for 
purposes of classification as a section 509(a)(1) organization, such 
organization need not be committed to spend every contribution for 
medical research before January 1 of the fifth calendar year which 
begins after the date such contribution is made.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972]



Sec. 1.509(a)-3  Broadly, publicly supported organizations.

    (a) In general--(1) General rule. Section 509(a)(2) excludes certain 
types of broadly, publicly supported organizations from private 
foundation status. An organization will be excluded under section 
509(a)(2) if it meets the one-third support test under section 
509(a)(2)(A) and the not-more-than-one-third support test under section 
509(a)(2)(B).
    (2) One-third support test. An organization will meet the one-third 
support test if it normally (within the meaning of paragraph (c), (d), 
or (e) of this section) receives more than one-third of its support in 
each taxable year from any combination of:
    (i) Gifts, grants, contributions, or membership fees, and
    (ii) Gross receipts from admissions, sales of merchandise, 
performance of services, or furnishing of facilities, in an activity 
which is not an unrelated trade or business (within the meaning of 
section 513), subject to certain limitations described in paragraph (b) 
of this section


from permitted sources. For purposes of this section, governmental 
units, organizations described in section 509(a)(1) and persons other 
than disqualified persons with respect to the organization shall be 
referred to as permitted sources. For purposes of this section, the 
amount of support received from the sources described in subdivisions 
(i) and (ii) of this subparagraph (subject to the limitations referred 
to in this subparagraph) will be referred to as the numerator of the 
one-third support total amount of support received (as defined in 
section 509(d)) will be referred to as the denominator of the one-third 
support fraction. For purposes of section 509(a)(2), paragraph (f) of 
this section distinguishes gifts and contributions from gross receipts; 
paragraph (g) of this section distinguishes grants from gross receipts; 
paragraph (h) of this section defines membership fees; paragraph (i) of 
this section defines any bureau or similar agency of a governmental 
unit; paragraph (j) of this section describes the treatment of certain 
indirect forms of support; paragraph (k) of this section describes the 
method of accounting for support; paragraph (l) of this section 
describes the treatment of gross receipts from section 513(a) (1), (2), 
or (3) activities; and paragraph (m) of this section distinguishes gross 
receipts from gross investment income.
    (3) Not-more-than-one-third support test--(i) In general. An 
organization will meet the not-more-than-one-third support test under 
section 509(a)(2)(B) if it normally (within the meaning of paragraph 
(c), (d), or (e) of this section) receives not more than one-third of 
its support in each taxable year from the sum of its gross investment 
income (as defined in section 509(e)) and the excess (if any) of the 
amount of its unrelated business taxable income (as defined in section 
512) derived from trades or businesses which were acquired by the 
organization after June 30, 1975, over the amount of tax imposed on such 
income by section 511. For purposes of this section the amount of 
support received from items described in section 509(a)(2)(B) will be 
referred to as the numerator of the not-more-than-one-third support 
fraction, and the total amount of support (as defined in section 509(d)) 
will be referred to as the denominator of the not-more-than-one-third 
support fraction. For purposes of section 509(a)(2), paragraph (m) of 
this section distinguishes gross receipts from gross investment income. 
For purposes of section 509(e), gross investment income includes the 
items of investment income described in Sec. 1.512(b)-1(a).
    (ii) Trade or business. For purposes of section 509(a)(2)(B)(ii), a 
trade or business acquired after June 30, 1975, by an organization shall 
include, in addition to other trades or businesses:

[[Page 120]]

    (A) A trade or business acquired after such date from, or as a 
result of the liquidation of, an organization's subsidiary which is 
described in section 502 whether or not the subsidiary was held on June 
30, 1975.
    (B) A new trade or business commenced by an organization after such 
date.
    (iii) Allocation of deductions between businesses acquired before, 
and businesses acquired after, June 30, 1975. Deductions which are 
allowable under section 512 but are not directly connected to a 
particular trade or business, such as deductions referred to in 
paragraphs (10) and (12) of section 512(b), shall be allocated in the 
proportion that the unrelated trade or business taxable income derived 
from trades or businesses acquired after June 30, 1975, bears to the 
organization's total unrelated business taxable income, both amounts 
being determined without regard to such deductions.
    (iv) Allocation of tax. The tax imposed by section 511 shall be 
allocated in the same proportion as in paragraph (a)(3)(iii) of this 
section.
    (4) Purposes. The one-third support test and the not-more-than-one-
third support test are designed to insure that an organization which is 
excluded from private foundation status under section 509(a)(2) is 
responsive to the general public, rather than to the private interests 
of a limited number of donors or other persons.
    (b) Limitation on gross receipts--(1) General rule. In computing the 
amount of support received from gross receipts under section 
509(a)(2)(A)(ii) for purposes of the one-third support test of section 
509(a)(2)(A), gross receipts from related activities received from any 
person, or from any bureau or similar agency of a governmental unit, are 
includible in any taxable year only to the extent that such receipts do 
not exceed the greater of $5,000 or 1 percent of the organization's 
support in such taxable year.
    (2) Examples. The application of this paragraph may be illustrated 
by the examples set forth below. For purposes of these examples, the 
term general public is defined as persons other than disqualified 
persons and other than persons from whom the foundation receives gross 
receipts in excess of the greater of $5,000 or 1 percent of its support 
in any taxable year, and the term gross receipts is limited to receipts 
from activities which are not unrelated trade or business (within the 
meaning of section 513).

    Example 1. For the taxable year 1970, X, an organization described 
in section 501(c)(3), received support of $10,000 from the following 
sources:

Bureau M (a governmental bureau from which X received gross      $25,000
 receipts for services rendered)............................
Bureau N (a governmental bureau from which X received gross       25,000
 receipts for services rendered)............................
General public (gross receipts for services rendered).......      20,000
Gross investment income.....................................      15,000
Contributions from individual substantial contributors            15,000
 (defined as disqualified persons under section 4946(a)(2)).
                                                             -----------
    Total support...........................................     100,000
 


Since the $25,000 received from each bureau amounts to more than the 
greater of $5,000 or 1 percent of X's support for 1970 (1% of 
$100,000=$1,000) under section 509(a)(2)(A)(ii), each amount is 
includible in the numerator of the one-third support fraction only to 
the extent of $5,000. Thus, for the taxable year 1970, X received 
support from sources which are taken into account in meeting the one-
third support test of section 509(a)(2)(A) computed as follows:

Bureau M....................................................      $5,000
Bureau N....................................................       5,000
General public..............................................      20,000
                                                             -----------
    Total...................................................      30,000
 

Therefore, in making the computations required under paragraph (c), (d), 
or (e) of this section, only $30,000 is includible in the aggregate 
numerator and $100,000 is includible in the aggregate denominator of the 
support fraction.
    Example 2. For the taxable year 1970, Y, an organization described 
in section 501(c)(3), received support of $600,000 from the following 
sources:

Bureau O (gross receipts for services rendered).............     $10,000
Bureau P (gross receipts for services rendered).............      10,000
General public (gross receipts for services rendered).......     150,000
General public (contributions)..............................      40,000
Gross investment income.....................................     150,000
Contributions from substantial contributors.................     240,000
                                                             -----------
    Total support...........................................     600,000
 


Since the $10,000 received from each bureau amounts to more than the 
greater of $5,000 or 1 percent of Y's support for 1970 (1% of 
$600,000=$6,000), each amount is includible in the numerator of the one-
third support fraction only to the extent of $6,000. Thus, for the 
taxable year 1970, Y received support from sources required to meet the 
one-third

[[Page 121]]

support test of section 509(a)(2)(A) computed as follows:

Bureau O....................................................      $6,000
Bureau P....................................................       6,000
General public (gross receipts).............................     150,000
General public (contributions)..............................      40,000
                                                             -----------
    Total...................................................     202,000
 

Therefore, in making the computations required under paragraph (c), (d), 
or (e) of this section, $202,000 is includible in the aggregate 
numerator and $600,000 is includible in the aggregate denominator of the 
support fraction.

    (c) Normally--(1) In general--( i) Definition. The support tests set 
forth in section 509(a)(2) are to be computed on the basis of the nature 
of the organization's normal sources of support. An organization will be 
considered as normally receiving one-third of its support from any 
combination of gifts, grants, contributions, membership fees, and gross 
receipts from permitted sources (subject to the limitations described in 
paragraph (b) of this section) and not more than one-third of its 
support from items described in section 509(a)(2)(B) for its current 
taxable year and the taxable year immediately succeeding its current 
year, if, for the 4 taxable years immediately preceding the current 
taxable year, the aggregate amount of the support received during the 
applicable period from gifts, grants, contributions, membership fees, 
and gross receipts from permitted sources (subject to the limitations 
described in paragraph (b) of this section) is more than one-third, and 
the aggregate amount of the support received from items described in 
section 509(a)(2)(B) is not more than one-third of the total support of 
the organization for such 4-year period.
    (ii) Exception for material changes in sources of support. If for 
the current taxable year there are substantial and material changes in 
an organization's sources of support other than changes arising from 
unusual grants excluded under subparagraph (3) of this paragraph, then 
in applying subdivision (i) of this subparagraph, neither the 4-year 
computation period, applicable to such year as an immediately succeeding 
taxable year, not the 4-year computation period, applicable to such year 
as a current taxable year shall apply, and in lieu of such computation 
periods there shall be applied a computation period consisting of the 
taxable year of substantial and material changes and the 4 taxable years 
immediately preceding such year. Thus, for example, if there are 
substantial and material changes in an organization's sources of support 
for taxable year 1976, then even though such organization meets the 
requirements of subdivision (i) of this subparagraph based on a 
computation period of taxable years 1971 through 1974 or 1972 through 
1975, such an organization will not meet the requirements of section 
509(a)(2) unless it meets the requirements of subdivision (i) of this 
subparagraph for a computation period of the taxable years 1972 through 
1976. See example 3 in subparagraph (6) of this paragraph for an 
illustration of this subdivision. An example of a substantial and 
material change is the receipt of an unusually large contribution or 
bequest which does not qualify as an unusual grant under subparagraph 
(3) of this paragraph. See subparagraph (5)(ii) of this paragraph as to 
the procedure for obtaining a ruling whether an unusually large grant 
may be excluded as an unusual grant.
    (iii) Status of grantors and contributors. (a) If as a result of 
subdivision (ii) of this subparagraph, an organization is not able to 
meet the requirements of either the one-third support test described in 
paragraph (a)(2) of this section or the not-more-than-one-third support 
test described in paragraph (a)(3) of this section for its current 
taxable year, its status (with respect to a grantor or contributor under 
sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 
2106(a)(2), and 2522) will not be affected until notice of change of 
status under section 509(a)(2) 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 substantial and material change referred to in 
subdivision (ii) of this subparagraph, or acquired knowledge that the 
Internal Revenue Service had given notice to such organization that it 
would be deleted from classification as section 509(a)(2) organization.

[[Page 122]]

    (b) A grantor or contributor other than one of the organization's 
founders, creators, or foundation managers (within the meaning of 
section 4946(b)) will not be considered to be responsible for, or aware 
of, the substantial and material change referred to in subdivision (ii) 
of this subparagraph if such grantor or contributor has made such grant 
or contribution in reliance upon a written statement by the grantee 
organization that such grant or contribution will not result in the loss 
of such organization's classification as not a private foundation under 
section 509(a). Such statement must be signed by a responsible officer 
of the grantee organization and must set forth sufficient information, 
including a summary of the pertinent financial data for the 4 preceding 
years, to assure a reasonably prudent man that his grant or contribution 
will not result in the loss of the grantee organization's classification 
as not a private foundation under section 509(a). If a reasonable doubt 
exists as to the effect of such grant or contribution, or if the grantor 
or contributor is one of the organization's founders, creators, or 
foundation managers, the procedure set forth in subparagraph (5)(ii) of 
this paragraph may be followed by the grantee organization for the 
protection of the grantor or contributor.
    (iv) Special rule for new organizations. If an organization has been 
in existence for at least 1 taxable year consisting of at least 8 
months, but for fewer than 5 taxable years, the number of years for 
which the organization has been in existence immediately preceeding each 
current taxable year being tested will be substituted for the 4-year 
period described in subdivision (i) of this subparagraph to determine 
whether the organization normally meets the requirements of paragraph 
(a) of this section. However, if subdivision (ii) of this subparagraph 
applies, then the period consisting of the number of years for which the 
organization has been in existence (up to and including the current 
year) will be substituted for the 4-year period described in subdivision 
(i) of this subparagraph. An organization which has been in existence 
for at least 1 taxable year, consisting of 8 or more months, may be 
issued a ruling or determination letter if it normally meets the 
requirements of paragraph (a) of this section for the number of years 
described in this subdivision. Such an organization may apply for a 
ruling or determination letter under the provisions of this paragraph, 
rather than under the provisions of paragraph (d) of this section. The 
issuance of a ruling or determination letter will be discretionary with 
the Commissioner. See paragraph (e)(4) of this section as to the initial 
determination of the status of a newly created organization. This 
subdivision shall not apply to those organizations receiving an extended 
advance ruling under paragraph (d)(4) of this section.
    (2) Terminations under section 507(b)(1)(B). For the special rules 
applicable to the term normally as applied to private foundations which 
elect to terminate their private foundation status pursuant to the 12-
month or 60-month procedure provided in section 507(b)(1)(B), see the 
regulations under such section.
    (3) Exclusion of unusual grants. For purposes of applying the 4-year 
aggregation test for support set forth in subparagraph (1) of this 
paragraph, one or more contributions (including contributions made prior 
to Jan. 1, 1970) may be excluded from the numerator of the one-third 
support fraction and from the denominator of both the one-third support 
and not-more-than-one-third support fractions only if such a 
contribution meets the requirements of this subparagraph. The exclusion 
provided by this subparagraph is generally intended to apply to 
substantial contributions and bequests from disinterested parties, which 
contributions or bequests:
    (i) Are attracted by reason of the publicly supported nature of the 
organization;
    (ii) Are unusual or unexpected with respect to the amount thereof; 
and
    (iii) Would by reason of their size, adversely affect the status of 
the organization as normally meeting the one-third support test for any 
of the applicable periods described in paragraph (c), (d), or (e) of 
this section.

In the case of a grant (as defined in paragraph (g) of this section) 
which

[[Page 123]]

meets the requirements of this subparagraph, if the terms of the 
granting instrument (whether executed before or after 1969) require that 
the funds be paid to the recipient organization over a period of years, 
the amount received by the organization each year pursuant to the terms 
of such grant may be excluded for such year. However, no item described 
in section 509(a)(2)(B) may be excluded under this subparagraph. The 
provisions of this subparagraph shall apply to exclude unusual grants 
made during any of the applicable periods described in paragraph (c), 
(d), or (e) of this section. See subparagraph (5)(ii) of this paragraph 
as to reliance by a grantee organization upon an unusual grant ruling 
under this subparagraph.
    (4) Determining factor. In determining whether a particular 
contribution may be excluded under subparagraph (3) of this paragraph, 
all pertinent facts and circumstances will be taken into consideration. 
No single factor will necessarily be determinative. Among the factors to 
be considered are:
    (i) Whether the contribution was made by any person (or persons 
standing in a relationship to such person which is described in section 
4946(a)(1) (C) through (G)) who created the organization, previously 
contributed a substantial part of its support or endowment, or stood in 
a position of authority, such as a foundation manager (within the 
meaning of section 4946(b)), with respect to the organization. A 
contribution made by a person other than those persons described in this 
subdivision will ordinarily be given more favorable consideration than a 
contribution made by a person described in this subdivision.
    (ii) Whether the contribution was a bequest or an inter vivos 
transfer. A bequest will ordinarily be given more favorable 
consideration than an inter vivos transfer.
    (iii) Whether the contribution was in the form of cash, readily 
marketable securities, or assets which further the exempt purposes of 
the organization, such as a gift of a painting to a museum.
    (iv) Except in the case of a new organization, whether, prior to the 
receipt of the particular contribution, the organization (a) has carried 
on an actual program of public solicitation and exempt activities and 
(b) has been able to attract a significant amount of public support.
    (v) Whether the organization may reasonably be expected to attract a 
significant amount of public support subsequent to the particular 
contribution. In this connection, continued reliance on unusual grants 
to fund an organization's current operating expenses (as opposed to 
providing new endowment funds) may be evidence that the organization 
cannot reasonably be expected to attract future support from the general 
public.
    (vi) Whether, prior to the year in which the particular contribution 
was received, the organization met the one-third support test described 
in subparagraph (1) of this paragraph without the benefit of any 
exclusions of unusual grants pursuant to subparagraph (3) of this 
paragraph;
    (vii) Whether neither the contributor nor any person standing in a 
relationship to such contributor which is described in section 
4946(a)(1) (C) through (G) continues directly or indirectly to exercise 
control over the organization;
    (viii) Whether the organization has a representative governing body 
as described in Sec. 1.509(a)-3(d)(3)(i); and
    (ix) Whether material restrictions or conditions (within the meaning 
of Sec. 1.507-2(a)(8)) have been imposed by the transferor upon the 
transferee in connection with such transfer.
    (5) Grantors and contributors. (i) As to the status of grants and 
contributions which result in substantial and material changes in the 
organization (as described in subparagraph (1)(ii) of this paragraph) 
and which fail to meet the requirements for exclusion under subparagraph 
(3) of this paragraph, see the rules prescribed in subparagraph (1)(iii) 
of this paragraph.
    (ii) Prior to the making of any grant or contribution which will 
allegedly meet the requirements for exclusion under subparagraph (3) of 
this paragraph, a potential grantee organization may request a ruling 
whether such grant or contribution may be so excluded. Requests for such 
ruling may be filed by the grantee organization with the district 
director. The issuance

[[Page 124]]

of such ruling will be at the sole discretion of the Commissioner. The 
organization must submit all information necessary to make a 
determination of the applicability of subparagraph (3) of this 
paragraph, including all information relating to the factors described 
in subparagraph (4) of this paragraph. If a favorable ruling is issued, 
such ruling may be relied upon by the grantor or contributor of the 
particular contribution in question for purposes of sections 170, 507, 
545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522 and 
by the grantee organization for purposes of subparagraph (3) of this 
paragraph.
    (6) Examples. The application of the principles set forth in this 
paragraph is illustrated by the examples set forth below. For purposes 
of these examples, the term general public is defined as persons other 
than disqualified persons and other than persons from whom the 
foundation received gross receipts in excess of the greater of $5,000 or 
1 percent of its support in any taxable year, the term gross investment 
income is as defined in section 509(e), and the term gross receipts is 
limited to receipts from activities which are not unrelated trade or 
business (within the meaning of section 513).

    Example 1. For the years 1970 through 1973, X, an organization 
exempt under section 501(c)(3) which makes scholarship grants to needy 
students of a particular city, received support from the following 
sources:

1970
Gross receipts (general public).............................     $35,000
Contributions (substantial contributors)....................      36,000
Gross investment income.....................................      29,000
                                                             -----------
    Total support...........................................     100,000
1971
Gross receipts (general public).............................      34,000
Contributions (substantial contributors)....................      35,000
Gross investment income.....................................      31,000
                                                             -----------
    Total support...........................................     100,000
1972
Gross receipts (general public).............................      35,000
Contributions (substantial contributors)....................      30,000
Gross investment income.....................................      35,000
                                                             -----------
    Total support...........................................     100,000
1973
Gross receipts (general public).............................      30,000
Contributions (substantial contributors)....................      39,000
Gross investment income.....................................      31,000
                                                             -----------
    Total support...........................................     100,000
 


In applying section 509(a)(2) to the taxable year 1974 on the basis of 
subparagraph (1)(i) of this paragraph, the total amount of support from 
gross receipts from the general public ($134,000) for the period 1970 
through 1973 was more than one-third, and the total amount of support 
from gross investment income ($126,000) was less than one-third, of its 
total support for the same period ($400,000). For the taxable years 1974 
and 1975, X is therefore considered normally to receive more than one-
third of its support from the public sources described in section 
509(a)(2)(A) and less than one-third of its support from items described 
in section 509(a)(2)(B) since due to the pattern of X's support, there 
are no substantial and material changes in the sources of the 
organization's support in these years. The fact that X received less 
than one-third of its support from section 509(a)(2)(A) sources in 1973 
and more than one-third of its support from items described in section 
509(a)(2)(B) in 1972 does not affect its status since it met the 
normally test over a 4-year period.
    Example 2. Assume the same facts as in example 1 except that in 1973 
X also received an unexpected bequest of $50,000 from A, an elderly 
widow who was interested in encouraging the work of X, but had no other 
relationship to it. Solely by reason of the bequest, A became a 
disqualified person. X used the bequest to create five new scholarships. 
Its operations otherwise remained the same. Under these circumstances X 
could not meet the 4-year support test since the total amount received 
from gross receipts from the general public ($134,000) would not be more 
than one-third of its total support for the 4-year period ($450,000). 
Since A is a disqualified person, her bequest cannot be included in the 
numerator of the one-third support test under section 509(a)(2)(A). 
However, based on the factors set forth in subparagraph (4) of this 
paragraph, A's bequest may be excluded as an unusual grant under 
subparagraph (3) of this paragraph. Therefore, X will be considered to 
have met the support test for the taxable years 1974 and 1975.
    Example 3. In 1970, Y, an organization described in section 
501(c)(3), was created by A, the holder of all the common stock in M 
corporation, B, A's wife, and C, A's business associate. Each of the 
three creators made small cash contributions to Y to enable it to begin 
operations. The purpose of Y was to sponsor and equip athletic teams for 
underprivileged children in the community. Between 1970 and 1973, Y was 
able to raise small amounts of contributions through fund raising drives 
and selling admission to some of the sponsored sporting events. For its 
first year of operations, it was determined that Y was excluded from the 
definition of private foundation under the provisions of section 
509(a)(2). A made small contributions to Y from time to time. At all 
times, the operations of Y were carried out on a small scale, usually 
being restricted to the sponsorship of

[[Page 125]]

two to four baseball teams of underprivileged children. In 1974, M 
recapitalized and created a first and second class of 6 percent 
nonvoting preferred stock, most of which was held by A and B. A then 
contributed 49 percent of his common stock in M to Y. A, B, and C 
continued to be active participants in the affairs of Y from its 
creation through 1974. A's contribution of M's common stock was 
substantial and constituted 90 percent of Y's total support for 1974. 
Although Y could satisfy the one-third support test on the basis of the 
four taxable years prior to 1974, a combination of the facts and 
circumstances described in subparagraph (4) of this paragraph preclude 
A's contribution of M's common stock in 1974 from being excluded as an 
unusual grant under subparagraph (3) of this paragraph. A's contribution 
in 1974 constituted a substantial and material change in Y's sources of 
support within the meaning of subparagraph (1)(ii) of this paragraph and 
on the basis of the 5-year period prescribed in subparagraph (1)(ii) of 
this paragraph (1970 to 1974), Y would not be considered as normally 
meeting the one-third support test described in paragraph (a)(2) of this 
section for the taxable years 1974 (the current taxable year) and 1975 
(the immediately succeeding taxable year).
    Example 4. M, an organization described in section 501(c)(3), was 
organized in 1971 to promote the appreciation of ballet in a particular 
region of the United States. Its principal activities will consist of 
erecting a theater for the performance of ballet and the organization 
and operation of a ballet company. The governing body of M consists of 9 
prominent unrelated citizens residing in the region who have either an 
expertise in ballet or a strong interest in encouraging appreciation of 
the art form. In order to provide sufficient capital for M to commence 
its activities, X, a private foundation, makes a grant of $500,000 in 
cash to M. Although A, the creator of X, is one of the nine members of 
M's governing body, was one of M's original founders, and continues to 
lend his prestige to M's activities and fund raising efforts, A does 
not, directly or indirectly, exercise any control over M. By the close 
of its first taxable year, M has also received a significant amount of 
support from a number of smaller contributions and pledges from other 
members of the general public. Upon the opening of its first season of 
ballet performances, M expects to charge admission to the general 
public. Under the above circumstances, the grant by X to M may be 
excluded as an unusual grant under subparagraph (3) of this paragraph 
for purposes of determining whether M meets the one-third support test 
under section 509(a)(2). Although A was a founder and member of the 
governing body of M, X's grant may be excluded.
    Example 5. Assume the same facts as Example 4. In 1974, during M's 
third season of operations, B, a widow, passed away and bequeathed $4 
million to M. During 1971 through 1973, B had made small contributions 
to M, none exceeding $10,000 in any year. During 1971 through 1974, M 
had received approximately $550,000 from receipts for admissions and 
contributions from the general public. At the time of B's death, no 
person standing in a relationship to B described in section 4946(a)(1) 
(C) through (G) was a member of M's governing body. B's bequest was in 
the form of cash and readily marketable securities. The only condition 
placed upon the bequest was that it be used by M to advance the art of 
ballet. Under the above circumstances, the bequest of B to M may be 
excluded as an unusual grant under subparagraph (3) of this paragraph 
for purposes of determining whether M meets the one-third support test 
under section 509(a)(2).
    Example 6. O is a research organization described in section 
501(c)(3). O was created by A in 1971 for the purpose of carrying on 
economic studies primarily through persons receiving grants from O and 
engaging in the sale of economic publications. O's five-member governing 
body consists of A, A's sons, B, and C, and two unrelated economists. In 
1971, A made a contribution to O of $100,000 to help establish the 
organization. During 1971 through 1974 A made annual contributions to O 
averaging $20,000 a year. During the same period, O received annual 
contributions from members of the general public averaging $15,000 per 
year and receipts from the sale of its publications averaging $50,000 
per year. In 1974, B made an inter vivos contribution to O of $600,000 
in cash and readily marketable securities. Undera majority vote, the 
governing body decided to retain the Y stock for a period of at least 5 
years. Under the above circumstances, A's contribution of the Y stock 
cannot be excluded as an unusual grant under subparagraph (3) of this 
paragraph for purposes of determining whether P meets the one-third 
support test.

    (d) Advance rulings to newly created organizations--(1) In general. 
A ruling or determination letter that an organization is described in 
section 509(a)(2) will not be issued to a newly created organization 
prior to the close of its first taxable year consisting of at least 8 
months. However, such organization may request a ruling or determination 
letter that it will be treated as a section 509(a)(2) organization for 
its first 2 taxable years (or its first 3 taxable years, if its first 
taxable year consists of less than 8 months). For purposes of this 
section such 2- or 3-year period, whichever is applicable, shall be 
referred to as the advance ruling period.

[[Page 126]]

Such an advance ruling or determination letter may be issued if the 
organization can reasonably be expected to meet the requirements of 
paragraph (a) of this section during the advance ruling period. The 
issuance of a ruling or determination letter will be discretionary with 
the Commissioner.
    (2) Basic consideration. In determinating whether an organization 
can reasonably be expected (within the meaning of subparagraph (1) of 
this paragraph) to meet the one-third support test under section 
509(a)(2)(A) and the not-more-than-one-third support test under section 
509(a)(2)(B) described in paragraph (a) of this section for its advance 
ruling period or extended advance ruling period as provided in 
subparagraph (4) of this paragraph, if applicable, the basic 
consideration is whether its organizational structure, proposed programs 
or activities, and intended method of operation are such as to attract 
the type of broadly based support from the general public, public 
charities, and governmental units which is necessary to meet such tests. 
While the factors which are relevant to this determination, and the 
weight accorded to each of them, may differ from case to case, depending 
on the nature and functions of the organization, a favorable 
determination will not be made where the facts indicate that an 
organization is likely during its advance or extended advance ruling 
period to receive less than one-third of its support from permitted 
sources (subject to the limitations of paragraph (b) of this section) or 
to receive more than one-third of its support from items described in 
section 509(a)(2)(B).
    (3) Factors taken into account. All pertinent facts and 
circumstances shall be taken into account under subparagraph (2) of this 
paragraph in determining whether the organizational structure, programs 
or activities, and method of operation of an organization are such as to 
enable it to meet the tests under section 509(a)(2) for its advance or 
extended advance ruling period. Some of the pertinent factors are:
    (i) Whether the organization has or will have a governing body which 
is comprised of public officials, or individuals chosen by public 
officials acting in their capacity as such, of persons having special 
knowledge in the particular field or discipline in which the 
organization is operating, of community leaders, such as elected 
officials, clergymen, and educators, or, in the case of a membership 
organization, of individuals elected pursuant to the organization's 
governing instrument or bylaws by a broadly based membership. This 
characteristic does not exist if the membership of the organization's 
governing body is such as to indicate that it represents the personal or 
private interests of disqualified persons, rather than the interests of 
the community or the general public.
    (ii) Whether a substantial portion of the organization's initial 
funding is to be provided by the general public, by public charities, or 
by government grants, rather than by a limited number of grantors or 
contributors who are disqualified persons with respect to the 
organization. The fact that the organization plans to limit its 
activities to a particular community or region or to a special field 
which can be expected to appeal to a limited number of persons will be 
taken into consideration in determining whether those persons providing 
the initial support for the organization are representative of the 
general public. On the other hand, the subsequent sources of funding 
which the organization can reasonably expect to receive after it has 
become established and fully operational will also be taken into 
account.
    (iii) Whether a substantial proportion of the organization's initial 
funds are placed, or will remain, in an endowment, and whether the 
investment of such funds is unlikely to result in more than one-third of 
its total support being received from items described in section 
509(a)(2)(B).
    (iv) In the case of an organization which carries on fund-raising 
activities, whether the organization has developed a concrete plan for 
solicitation of funds from the general public on a community or area-
wide basis; whether any steps have been taken to implement such plan; 
whether any firm commitments of financial or other support have been 
made to the organization by civic, religious, charitable, or similar 
groups within the community; and whether the organization has made any

[[Page 127]]

commitments to, or established any working relationships with, those 
organizations or classes of persons intended as the future recipients of 
its funds.
    (v) In the case of an organization which carries on community 
services, such as slum clearance and employment opportunities, whether 
the organization has a concrete program to carry out its work in the 
community; whether any steps have been taken to implement that program; 
whether it will receive any part of its funds from a public charity or 
governmental agency to which it is in some way held accountable as a 
condition of the grant or contribution; and whether it has enlisted the 
sponsorship or support of other civic or community leaders involved in 
community service programs similar to those of the organization.
    (vi) In the case of an organization which carries on educational or 
other exempt activities for, or on behalf of, members, whether the 
solicitation for dues-paying members is designed to enroll a substantial 
number of persons in the community, area, profession, or field of 
special interest (depending on the size of the area and the nature of 
the organization's activities); whether membership dues for individual 
(rather than institutional) members have been fixed at rates designed to 
make membership available to a broad cross-section of the public rather 
than to restrict membership to a limited number of persons; and whether 
the activities of the organization will be likely to appeal to persons 
having some broad common interest or purpose, such as educational 
activities in the case of alumni associations, musical activities in the 
case of symphony societies, or civic affairs in the case of parent-
teacher associations.
    (vii) In the case of an organization which provides goods, services, 
or facilities, whether the organization is or will be required to make 
its services, facilities, performances, or products available 
(regardless of whether a fee is charged) to the general public, public 
charities, or governmental units, rather than to a limited number of 
persons or organizations; whether the organization will avoid executing 
contracts to perform services for a limited number of firms or 
governmental agencies or bureaus; and whether the service to be provided 
is one which can be expected to meet a special or general need among a 
substantial portion of the general public.
    (4) Extension of advance ruling period. (i) The advance ruling 
period described in subparagraph (1) of this paragraph shall be extended 
for a period of 3 taxable years after the close of the unextended 
advance ruling period if the organization so requests, but only if such 
organization's request accompanies its request for an advance ruling and 
is filed with a consent under section 6501(c)(4) to the effect that the 
period of limitation upon assessment under section 4940 for any taxable 
year within the extended advance ruling period shall not expire prior to 
1 year after the date of the expiration of the time prescribed by law 
for the assessment of a deficiency for the last taxable year within the 
extended advance ruling period. An organization's extended advance 
ruling period is 5 taxable years if its first taxable year consists of 
at least 8 months, or is 6 taxable years if its first taxable year is 
less than 8 months.
    (ii) Notwithstanding subdivision (i) of this subparagraph, an 
organization which has received or applied for an advance ruling prior 
to October 16, 1972, may file its request for the 3-year extension 
within 90 days from such date, but only if it files the consents 
required in this section.
    (iii) See paragraph (e)(4)(i)(d) of this section for the effect upon 
the initial determination of status of an organization which receives an 
advance ruling for an extended advance ruling period.
    (e) Status of newly created organizations--(1) Advance or extended 
advance ruling. This subparagraph shall apply to a newly created 
organization which has received a ruling or determination letter under 
paragraph (d) of this section that it be treated as a section 509(a)(2) 
organization for its advance or extended advance ruling period. So long 
as such an organization's ruling or determination letter has not been 
terminated by the Commissioner before the expiration of the advance or 
extended advance ruling period, then whether or not such organization 
has satisfied the requirements of paragraph

[[Page 128]]

(a) of this section during such advance or extended advance ruling 
period, such an organization will be treated as an organization 
described in section 509(a)(2) in accordance with subparagraphs (2) and 
(3) of this paragraph, both for purposes of the organization and any 
grantor or contributor to such organization.
    (2) Reliance period. Except as provided in subparagraphs (1) and (3) 
of this paragraph, an organization described in subparagraph (1) of this 
paragraph will be treated as an organization described in section 
509(a)(2) for all purposes other than section 507(d) and 4940 for the 
period beginning with its inception and ending 90 days after its advance 
or extended advance ruling period. Such period will be extended until a 
final determination is made of such an organization's status only if the 
organization submits, within the 90-day period, information needed to 
determine whether it meets the requirements of paragraph (a) of this 
section for its advance or extended advance ruling period (even if such 
organization fails to meet the requirements of such paragraph (a)). 
However, since this subparagraph does not apply to section 4940, if it 
is subsequently determined that the organization was a private 
foundation from its inception, then the tax imposed by section 4940 
shall be due without regard to the advance ruling or determination 
letter. Consequently, if any amount of tax under section 4940 in such a 
case is not paid on or before the last date prescribed for payment, the 
organization is liable for interest in accordance with section 6601. 
However, since any failure to pay such tax during the period referred to 
in this subparagraph is due to reasonable cause, the penalty under 
section 6651 with respect to the tax imposed by section 4940 shall not 
apply.
    (3) Grantors or contributors. If a ruling or determination letter is 
terminated by the Commissioner prior to the expiration of the period 
described in subparagraph (2) of this paragraph, for purposes of 
sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 4942, 4945, 2055, 
2106(a)(2), and 2522 the status of grants or contributions with respect 
to grantors or contributors to such organizations will not be affected 
until notice of change of status of such organization is made to the 
public (such as by publication of the Internal Revenue Bulletin). The 
preceding sentence shall not apply, however, if the grantor or 
contributor was responsible for, or aware of, the act or failure to act 
that resulted in the organization's loss of classification under section 
509(a)(2) or acquired knowledge that the Internal Revenue Service had 
given notice to such organization that it would be deleted from such 
classification. See, however, Sec. 1.509(a)-3(c)(5)(ii) for the 
procedures to be followed to protect the grantor or contributor from 
being considered responsible for, or aware of, the act or failure to act 
resulting in the grantee's loss of classification under section 
509(a)(2).
    (4) Initial determination of status--(i) New organizations. (a) The 
initial determination of status of a newly created organization is the 
first determination (other than by issuance of an advance ruling or 
determination letter under paragraph (d) of this section) that the 
organization will be considered as normally meeting the requirements of 
paragraph (a) of this section for a period beginning with its first 
taxable year.
    (b) In the case of a new organization whose first taxable year is at 
least 8 months, except as provided for in subdivision (i)(d) of this 
subparagraph, the initial determination of status shall be based on a 
computation period of either the first taxable year or the first and 
second taxable years.
    (c) In the case of a new organization whose first taxable year is 
less than 8 taxable months, except as provided for in subdivision (i)(d) 
of this subparagraph, the initial determination of status shall be based 
on a computation period of either the first and second taxable years or 
the first, second and third taxable years.
    (d) In the case of an organization which has received a ruling or 
determination letter for an extended advance ruling period under 
paragraph (d)(4) of this section, the initial determination of status 
shall be based on a computation period of all of the taxable years in 
the extended advance ruling period. However, where the ruling or 
determination letter for an extended advance ruling period under 
paragraph

[[Page 129]]

(d)(4) of this section is terminated by the Commissioner prior to the 
expiration of the period described in subparagraph (2) of this 
paragraph, the initial determination of status shall be based on a 
computation period of the period provided for in (b) or (c) of this 
subdivision or, if greater, the number of years to which the advance 
ruling applies.
    (e) An initial determination that an organization will be considered 
as normally meeting the requirements of paragraph (a) of this section 
shall be effective for each taxable year in the computation period plus 
(except as provided by paragraph (c)(1)(ii) of this section relating to 
material changes in sources of support) the two taxable years 
immediately succeeding the computation period. Therefore, in the case of 
an organization referred to in (b) of this subdivision to which 
paragraph (c)(1)(ii) of this section does not apply, with respect to its 
first, second, and third taxable years, such an organization shall be 
described in section 509(a)(2) if it meets the requirements of paragraph 
(a) of this section for either its first taxable year or for its first 
and second taxable years on an aggregate basis. In addition, if it meets 
the requirements of paragraph (a) of this section for its first and 
second taxable years it shall be described in section 509(a)(2) for its 
fourth taxable year. Once an organization is considered as normally 
meeting the requirements of paragraph (a) for a period specified under 
this subdivision, paragraph (c)(1) (i), (ii), or (iv) of this section 
shall apply.
    (f) The provisions of this subdivision may be illustrated by the 
following examples:

    Example 1. X, a calendar year organization described in section 
501(c)(3), is created in February 1972 for the purpose of displaying 
African art. The support X received from the public in 1972 satisfies 
the one-third support and not-more-than-one-third support tests 
described in section 509(a)(2) for its first taxable year, 1972. X may 
therefore get an initial determination that it meets the requirements of 
paragraph (a) of this section for its first taxable year beginning in 
February 1972 and ending on December 31, 1972. This determination will 
be effective for taxable years 1972, 1973, and 1974.
    Example 2. Assume the same facts as in example 1 except that X also 
receives a substantial contribution from one individual in 1972 which is 
not excluded from the denominator of the one-third support fraction 
described in section 509(a)(2) by reason of the unusual grant provision 
of subparagraph (c)(3) of this section. Because of this substantial 
contribution, X fails to satisfy the one-third support test over its 
first taxable year, 1972. However, the support received from the public 
over X's first and second taxable years in the aggregate satisfies the 
one-third support and not-more-than-one-third support tests. X may 
therefore get an initial determination that it meets the requirements of 
paragraph (a) of this section for its first and second taxable years in 
the aggregate beginning in February 1972 and ending on December 31, 
1973. This determination will be effective for taxable years 1972, 1973, 
1974, and 1975.
    Example 3. Y, a calendar year organization described in section 
501(c)(3), is created in July 1972 for the encouragement of the musical 
arts. Y requests and receives an extended advance ruling period of five 
full taxable years plus its initial short taxable year of 6 months under 
subparagraph (d)(4) of this section. The extended advance ruling period 
begins in July 1972 and ends on December 31, 1977. The support received 
from the public over Y's first through sixth taxable years in the 
aggregate will satisfy the one-third support and not-more-than-one-third 
support tests described in section 509(a)(2). Therefore, Y in 1978 may 
get an initial determination that it meets the requirements of paragraph 
(a) of this section in the aggregate over all the taxable years in its 
extended advance ruling period beginning in July 1972 and ending on 
December 31, 1977. This determination will be effective for taxable 
years 1972 through 1979.
    Example 4. Assume the same facts as in examples 3 except that the 
ruling for the extended advance ruling period is terminated 
prospectively at the end of 1975, so that Y may not rely upon such 
ruling for 1976 or any succeeding year. The support received from the 
public over Y's first through fourth taxable years (1972 through 1975) 
will not satisfy the one-third support and not-more-than-one-third 
support tests described in section 509(a)(2). Because the ruling was 
terminated, the computation period for Y's initial determination of 
status is the period 1972 through 1975. Since Y has not met the 
requirements of paragraph (a) of this section for such computation 
period, Y is not described in section 509(a)(2) for purposes of its 
initial determination of status. If Y is not described in section 509(a) 
(1), (3), or (4), then Y is a private foundation. As of 1976, Y shall be 
treated as a private foundation for all purposes (except as provided in 
subparagraph (3) of this paragraph with respect to grantors and 
contributors), and as of July 1972 for purposes of the tax imposed by 
section 4940 and for purposes

[[Page 130]]

of section 507(d) (relating to aggregate tax benefit).

    (ii) Advance rulings. Unless a newly created organization has 
obtained a ruling or determination letter under paragraph (d) of this 
section that it be treated as a section 509(a)(2) organization for its 
advance or extended advance ruling period, it can not rely upon the 
possibility it will meet the requirements of paragraph (a) of this 
section for a taxable year which begins before the close of either 
applicable computation period provided for in subdivision (i) (b) or (c) 
of this subparagraph. Therefore, an organization which has not obtained 
such a ruling or determination letter, in order to avoid the risks 
associated with subsequently being determined to be a private 
foundation, may comply with the rules applicable to private foundations, 
and may pay, for example, the tax imposed by section 4940. In that 
event, if the organization subsequently meets the requirements of 
paragraph (a) for either applicable computation period, it shall be 
treated as a section 509(a)(2) organization from its inception, and, 
therefore, any tax imposed under chapter 42 shall be refunded and 
section 509(b) shall not apply.
    (iii) Penalties. If a newly created organization fails to obtain a 
ruling or determination letter under paragraph (d) of this section, and 
fails to meet the requirements of paragraph (a) of this section for the 
first applicable computation period provided for in subdivision (i) (b) 
or (c) of this subparagraph, see section 6651 for penalty for failure to 
file return and pay tax.
    (iv) Examples. This subparagraph may be illustrated by the following 
examples:

    Example 1. On January 1, 1972, A contributes $100,000 to X, an 
organization described in section 501(c)(3) which he created on such 
date. X is not described in section 509(a) (1), (3), or (4). X's 
governing instrument does not contain the provisions referred to in 
section 508(e). Therefore, A is not entitled to a deduction under 
section 170 for the $100,000 contribution by reason of section 
508(d)(2)(A) unless X is described in section 509(a)(2). If X meets the 
requirements of section 509(a)(2) for 1972 and 1973 on an aggregate 
basis, then whether or not X met the requirements of section 509(a)(2) 
for 1972 based on the support received in 1972, X would not have to meet 
the governing instrument requirements of section 508(e), and section 
508(d)(2)(A) would not prevent A from claiming the deduction under 
section 170 for 1972. If X fails to meet the requirements of section 
509(a)(2) for both 1972 and, on an aggregate basis, 1972 and 1973, X 
would lose its exempt status under section 508(e) for both 1972 and 
1973, and A would be barred by section 508(d)(2)(A) from claiming a 
deduction for the $100,000 contribution to X.
    Example 2. Assume the same facts as in example 1 except that X's 
governing instrument contains provisions which meet the requirements of 
section 508(e) in the event X is a private foundation, but do not apply 
to X in the event X is not a private foundation. Whether or not X meets 
the requirements of section 509(a)(2) for 1972 based on the support 
received in 1972 or 1972 and 1973 on an aggregate basis, since X meets 
the requirements of section 508(e), section 508(d)(2)(A) would not bar A 
from claiming a deduction under section 170 for 1972 for the 
contribution to X.

    (f) Gifts and contributions distinguished from gross receipts--(1) 
In general. In determining whether an organization normally receives 
more than one-third of its support from permitted sources, all gifts and 
contributions (within the meaning of section 509(a)(2)(A)(i)) received 
from permitted sources, are includible in the numerator of the support 
fraction in each taxable year. However, gross receipts (within the 
meaning of section 509(a)(2)(A)(ii)) from admissions, sales of 
merchandise, performance of services, or furnishing of facilities, in an 
activity which is not an unrelated trade or business, are includible in 
the numerator of the support fraction in any taxable year only to the 
extent that such gross receipts do not exceed the limitation with 
respect to the greater of $5,000 or 1 percent of support which is 
describing paragraph (b) of this section. The terms gifts and 
contributions shall, for purposes of section 509(a)(2), have the same 
meaning as such terms have under section 170(c) and also include 
bequests, legacies, devises, and transfers within the meaning of section 
2055 or 2106(a)(2). Thus, for purposes of section 509(a)(2)(A), any 
payment of money or transfer of property without adequate consideration 
shall be considered a gift or contribution. Where payment is made or 
property transferred as consideration for admissions, sales

[[Page 131]]

of merchandise, performance of services, or furnishing of facilities to 
the donor, the status of the payment or transfer under section 170(c) 
shall determine whether and to what extent such payment or transfer 
constitutes a gift or contribution under section 509(a)(2)(A)(i) as 
distinguished from gross receipts from related activities under section 
509(a)(2)(A)(ii). For purposes of section 509(a)(2), the term 
contributions includes qualified sponsorship payments (as defined in 
Sec. 1.513-4) in the form of money or property (but not services).
    (2) Valuation of property. For purposes of section 509(a)(2), the 
amount includible in computing support with respect to gifts, grants or 
contributions of property or use of such property shall be the fair 
market or rental value of such property at the date of such gift or 
contribution.
    (3) Examples. The provisions of this paragraph (f) may be 
illustrated by the following examples:

    Example 1. P is a local agricultural club described in section 
501(c)(3). In order to encourage interest and proficiency by young 
people in farming and raising livestock, it makes awards at its annual 
fair for outstanding specimens of produce and livestock. Most of these 
awards are cash or other property donated by local businessmen. When the 
awards are made, the donors are given recognition for their donations by 
being identified as the donor of the award. The recognition given to 
donors is merely incidental to the making of the award to worthy 
youngsters. For these reasons, the donations will constitute 
contributions for purposes of section 509(a)(2)(A)(i). The amount 
includible in computing support with respect to such contributions is 
equal to the cash contributed or the fair market value of other property 
on the dates contributed.
    Example 2. Q, a performing arts center, enters into a contract with 
a large company to be the exclusive sponsor of the center's theatrical 
events. The company makes a payment of cash and products in the amount 
of $100,000 to Q, and in return, Q agrees to make a broadcast 
announcement thanking the company before each show and to provide $2,000 
of advertising in the show's program (2% of $100,000 is $2,000). The 
announcement constitutes use or acknowledgment pursuant to section 
513(i)(2). Because the value of the advertising does not exceed 2% of 
the total payment, the entire $100,000 is a qualified sponsorship 
payment under section 513(i), and $100,000 is treated as a contribution 
for purposes of section 509(a)(2)(A)(i).
    Example 3. R, a charity, enters into a contract with a law firm to 
be the exclusive sponsor of the charity's outreach program. Instead of 
making a cash payment, the law firm agrees to perform $100,000 of legal 
services for the charity. In return, R agrees to acknowledge the law 
firm in all its informational materials. The total fair market value of 
the legal services, or $100,000, is a qualified sponsorship payment 
under section 513(i), but no amount is treated as a contribution under 
section 509(a)(2)(A)(i) because the contribution is of services.

    (g) Grants distinguished from gross receipts--(1) In general. In 
determining whether an organization normally receives more than one-
third of its support from public sources, all grants (within the meaning 
of section 509(a)(2)(A)(i)) received from permitted sources are 
includible in full in the numerator of the support fraction in each 
taxable year. However, gross receipts (within the meaning of section 
509(a)(2)(A)(ii)) from admissions, sales of merchandise, performance of 
services, or furnishing of facilities, in an activity which is not an 
unrelated trade or business, are includible in the numerator of the 
support fraction in any taxable year only to the extent that such gross 
receipts do not exceed the limitation with respect to the greater of 
$5,000 or 1 percent of support which is described in paragraph (b) of 
this section. A grant is normally made to encourage the grantee 
organization to carry on certain programs or activities in furtherance 
of its exempt purposes. It may contain certain terms and conditions 
imposed by the grantor to insure that the grantee's programs or 
activities are conducted in a manner compatible with the grantor's own 
programs and policies and beneficial to the public. The grantee may also 
perform a service or produce a work product which incidentally benefits 
the grantor. Because of the imposition of terms and conditions, the 
frequent similarlity of public purposes of grantor and grantee, and the 
possibility of benefit resulting to the grantor, amounts received as 
grants for the carrying on of exempt activities are sometimes difficult 
to distinguish from amounts received as gross receipts from the carrying 
on of exempt activities. The fact that the agreement, pursuant

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to which payment is made, is designated a contract or a grant is not 
controlling for purposes of classifying the payment under section 
509(a)(2).
    (2) Distinguishing factors. For purposes of section 
509(a)(2)(A)(ii), in distinguishing the term gross receipts from the 
term grants, the term gross receipts means amounts received from an 
activity which is not an unrelated trade or business, if a specific 
service, facility, or product is provided to serve the direct and 
immediate needs of the payor, rather than primarily to confer a direct 
benefit upon the general public. In general, payments made primarily to 
enable the payor to realize or receive some economic or physical benefit 
as a result of the service, facility, or product obtained will be 
treated as gross receipts with respect to the payee. The fact that a 
profitmaking organization would, primarily for its own economic or 
physical betterment, contract with a nonprofit organization for the 
rendition of a comparable service, facility or product from such 
organization constitutes evidence that any payments received by the 
nonprofit payee organization (whether from a governmental unit, a 
nonprofit or a profitmaking organization) for such services, facilities 
or products are primarily for the economic or physical benefit of the 
payor and would therefore be considered gross receipts, rather than 
grants with respect to the payee organization. For example, if a 
nonprofit hospital described in section 170(b)(1)(A)(iii) engages an 
exempt research and development organization to develop a more 
economical system of preparing food for its own patients and personnel, 
and it can be established that a hospital operated for profit might 
engage the services of such an organization to perform a similar benefit 
for its economic betterment, such fact would constitute evidence that 
the payments received by the research and development organization 
constitute gross receipts, rather than grants. Research leading to the 
development of tangible products for the use or benefit of the payor 
will generally be treated as a service provided to serve the direct and 
immediate needs of the payor, while basic research or studies carried on 
in the physical or social sciences will generally be treated as 
primarily to confer a direct benefit upon the general public.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. M, a nonprofit research organization described in section 
501(c)(3), engages in some contract research. It receives funds from the 
government to develop a specific electronic device needed to perfect 
articles of space equipment. The initiative for the project came solely 
from the government. Furthermore, the government could have contracted 
with profitmaking research organizations which carry on similar 
activities. The funds received from the government for this project are 
gross receipts and do not constitute grants within the meaning of 
section 509(a)(2)(A)(i). M provided a specific product at the 
government's request and thus was serving the direct and immediate needs 
of the payor within the meaning of subparagraph (2) of this paragraph.
    Example 2. N is a nonprofit educational organization described in 
section 501(c)(3). Its principal activity is to operate institutes to 
train employees of various industries in the principles of management 
and administration. The government pays N to set up a special institute 
for certain government employees and to train them over a 2-year period. 
Management training is also provided by profitmaking organizations. The 
funds received are included as gross receipts. The particular services 
rendered were to serve the direct and immediate needs of the government 
in the training of its employees within the meaning of subparagraph (2) 
of this paragraph.
    Example 3. The Office of Economic Opportunity makes a community 
action program grant to O, an organization described in section 
509(a)(1). O serves as a delegate agency of OEO for purposes of 
financing a local community action program. As part of this program, O 
signs an agreement with X, an educational and charitable organization 
described in section 501(c)(3), to carry out a housing program for the 
benefit of poor families. Pursuant to this agreement, O pays X out of 
the funds provided by OEO to build or rehabilitate low income housing 
and to provide advisory services to other nonprofit organizations in 
order for them to meet similar housing objectives, all on a nonprofit 
basis. Payments made from O to X constitute grants for purposes of 
section 509(a)(2)(A) because such program is carried on primarily for 
the direct benefit of the community.
    Example 4. P is an educational institute described in section 
501(c)(3). It carries on studies and seminars to assist institutions of 
higher learning. It receives funds from the government to research and 
develop a program of black studies for institutions of

[[Page 133]]

higher learning. The performance of such a service confers a direct 
benefit upon the public. Because such program is carried on primarily 
for the direct benefit of the public, the funds are considered a grant.
    Example 5. Q is an organization described in section 501(c)(3) which 
carries on medical research. Its efforts have primarily been directed 
toward cancer research. Q sought funds from the government for a 
particular project being contemplated in connection with its work. In 
order to encourage its activities, the government gives Q the sum of 
$25,000. The research project sponsored by government funds is primarily 
to provide direct benefit to the general public, rather than to serve 
the direct and immediate needs of the government. The funds are 
therefore considered a grant.
    Example 6. R is a public service organization described in section 
501(c)(3) and composed of State and local officials involved in public 
works activities. The Bureau of Solid Waste, Management of the 
Department of Health, Education, and Welfare paid R to study the 
feasibility of a particular system for disposal of solid waste. Upon 
completion of the study, R was required to prepare a final report 
setting forth its findings and conclusions. Although R is providing the 
Bureau of Solid Waste Management with a final report, such report is the 
result of basic research and study in the physical sciences and is 
primarily to provide direct benefit to the general public by serving to 
further the general functions of government, rather than a direct and 
immediate governmental needs. The funds paid to R are therefore a grant 
within the meaning of section 509(a)(2).
    Example 7. R is the public service organization referred to in 
example 6. W, a municipality described in section 170(c)(1), decides to 
construct a sewage disposal plant. W pays R to study a number of 
possible locations for such plant and to make recommendations to W, 
based upon a number of factors, as to the best location. W instructed R 
that in making its recommendation, primary consideration should be given 
to minimizing the costs of the project to W. Since the study 
commissioned by W was primarily directed toward producing an economic 
benefit to W in the form of minimizing the costs of its project, the 
services rendered are treated as serving W's direct and immediate needs 
and are includible as gross receipts by R.
    Example 8. S in an organization described in section 501(c)(3). It 
was organized and is operated to further African development and 
strengthen understanding between the United States and Africa. To 
further these purposes, S receives funds from the Agency for 
International Development and the Department of State under which S is 
required to carry out the following programs: Selection, transportation, 
orientation, counseling, and language training of African students 
admitted to American institutions of higher learning; payment of 
tuition, other fees, and maintenance of such students; and operation of 
schools and vocational training programs in underdeveloped countries for 
residents of those countries. Since the programs carried on by S are 
primarily to provide direct benefit to the general public, all of the 
funds received by S from the Federal agencies are considered grants 
within the meaning of section 509(a)(2).

    (h) Definition of membership fees--(1) General rule. For purposes of 
section 509(a)(2), the fact that a membership organization provides 
services, admissions, facilities, or merchandise to its members as part 
of its overall activities will not, in itself, result in the 
classification of fees received from members as gross receipts rather 
than membership fees. If an organization uses membership fees as a means 
of selling admissions, merchandise, services, or the use of facilities 
to members of the general public who have no common goal or interest 
(other than the desire to purchase such admissions, merchandise, 
services, or use of facilities), then the income received from such fees 
shall not constitute membership fees under section 509(a)(2)(A)(i), but 
shall, if from a related activity, constitute gross receipts under 
section 509(a)(2)(A)(ii). On the other hand, to the extent the basic 
purpose for making the payment is to provide support for the 
organization rather than to purchase admissions, merchandise, services, 
or the use of facilities, the income received from such payment shall 
constitute membership fees.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M is a symphony society described in section 501(c)(3). 
Its primary purpose is to support the local symphony orchestra. The 
organization has three classes of membership. Contributing members pay 
annual dues of $10, sustaining members pay $25, and honorary members pay 
$100. The dues are placed in a maintenance fund which is used to provide 
financial assistance in underwriting the orchestra's annual deficit. 
Members have the privilege of purchasing subscriptions to the concerts 
before they go on sale to the general public, but must pay the same 
price as any other member of the public. They also are entitled to 
attend a number of rehearsals each season without

[[Page 134]]

charge. Under these circumstances, M's receipts from the members 
constitute membership fees for purposes of section 509(a)(2)(A)(i).
    Example 2. N is a theater association described in section 
501(c)(3). Its purpose is to support a repertory company in the 
community in order to make live theatrical performances available to the 
public. The organization sponsors six plays each year. Members of the 
organization are entitled to a season subscription to the plays. The fee 
paid as dues approximates the retail price of the six plays, less a 10-
percent discount. Tickets to each performance are also sold directly to 
the general public. The organization also holds a series of lectures on 
the theater which members may attend. Under these circumstances, the 
fees paid by members as dues will be considered gross receipts from a 
related activity. Although the fees are designated as membership fees, 
they are actually admissions to a series of plays.

    (i) Bureau defined--(1) In general. The term any bureau or similar 
agency of a governmental unit (within the meaning of section 
509(a)(2)(A)(ii)), refers to a specialized operating unit of the 
executive, judicial, or legislative branch of government where business 
is conducted under certain rules and regulations. Since the term bureau 
refers to a unit functioning at the operating, as distinct from the 
policymaking, level of government, it is normally descriptive of a 
subdivision of a department of government. The term bureau, for purposes 
of section 509(a)(2)(A)(ii), would therefore not usually include those 
levels of government which are basically policymaking or administrative, 
such as the office of the Secretary or Assistant Secretary of a 
department, but would consist of the highest operational level under 
such policymaking or administrative levels. Each subdivision of a larger 
unit within the Federal Government, which is headed by a Presidential 
appointee holding a position at or above Level V of the Executive 
Schedule under 5 U.S.C. 5316, will normally be considered an 
administrative or policymaking, rather than an operating, unit. Amounts 
received from a unit functioning at the policymaking or administrative 
level of government will be treated as received from one bureau or 
similar agency of such unit. Units of a governmental agency above the 
operating level shall be aggregated and considered a separate bureau for 
this purpose. Thus, an organization receiving gross receipts from both a 
policymaking or administrative unit and an operational unit of a 
department will be treated as receiving gross receipts from two bureaus 
within the meaning of section 509(a)(2)(A)(ii). For purposes of this 
subparagraph, the Departments of Air Force, Army, and Navy are separate 
departments and each is considered as having its own policymaking, 
administrative, and operating units.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. The Bureau of Health Insurance is considered a bureau 
within the meaning of section 509(a)(2)(A)(ii). It is a part of the 
Department of Health, Education, and Welfare, whose Secretary performs a 
policymaking function, and is under the Social Security Administration, 
which is basically an administrative unit. The Bureau of Health 
Insurance is in the first operating level within the Social Security 
Administration. Similarly, the National Cancer Institute would be 
considered a bureau, as it is an operating part of the National 
Institutes of Health within the Department of Health, Education, and 
Welfare.
    Example 2. The Bureau for Africa and the Bureau for Latin America 
are considered bureaus within the meaning of section 509(a)(2)(A)(ii). 
Both are separate operating units under the administrator of the Agency 
for International development, a policymaking official. If an 
organization received gross receipts from both of these bureaus, the 
amount of gross receipts received from each would be subject to the 
greater of $5,000 or 1 percent limitation under section 
509(a)(2)(A)(ii).
    Example 3. The Bureau of International Affairs of the Civil 
Aeronautics Board is considered a bureau within the meaning of section 
509(a)(2)(A)(ii). It is an operating unit under the administrative 
office of the Executive Director. The subdivisions of the Bureau of 
International Affairs are Geographic Areas and Project Development 
Staff. If an organization received gross receipts from these 
subdivisions, the total gross receipts from these subdivisions would be 
considered gross receipts from the same bureau, the Bureau of 
International Affairs, and would be subject to the greater of $5,000 or 
1 percent limitation under section 509(a)(2)(A)(ii).
    Example 4. The Department of Mental Health, a State agency which is 
an operational part of State X's Department of Public Health, is 
considered a bureau. The Department of Public Health is basically an 
administrative agency and the Department of

[[Page 135]]

Mental Health is at the first operational level within it.
    Example 5. The Aeronautical Systems Division of the Air Force 
Systems Command, and other units on the same level, are considered 
separate bureaus with the meaning of section 509(a)(2)(A)(ii). They are 
part of the Department of the Air Force which is a separate department 
for this purpose, as are the Army and Navy. The Secretary and the Under 
Secretary of the Air Force perform the policymaking function, the Chief 
of Staff and the Air Force Systems Command are basically administrative, 
having a comprehensive complement of staff functions to provide 
administration for the various divisions. The Aeronautical Systems 
Division and other units on the same level are thus the first operating 
level, as evidenced by the fact that they are the units that let 
contracts and perform the various operating functions.
    Example 6. The Division of Space Nuclear Systems, the Division of 
Biology and Medicine, and other units on the same level within the 
Atomic Energy Commission are each separate bureaus within the meaning of 
section 509(a)(2)(A)(ii). The Commissioners (which make up the 
Commission) are the policymakers. The general manager and the various 
assistant general managers perform the administrative function. The 
various divisions perform the operating function as evidenced by the 
fact that each has separate programs to pursue and contracts 
specifically for these various programs.

    (j) Grants from public charities--(1) General rule. For purposes of 
the one-third support test in section 509(a)(2)(A), grants (as defined 
in paragraph (g) of this section) received from an organization 
described in section 509(a)(1) (hereinafter referred to in this 
subparagraph as a public charity) are generally includible in full in 
computing the numerator of the recipient's support fraction of the 
taxable year in question. It is sometimes necessary to determine whether 
the recipient of a grant from a public charity has received such support 
from the public charity as a grant, or whether the recipient has in fact 
received such support as an indirect contribution from a donor to the 
public charity. If the amount received is considered a grant from the 
public charity, it is fully includible in the numerator of the support 
fraction under section 509(a)(2)(A). However, if the amount received is 
considered to be an indirect contribution from one of the public 
charity's donors which has passed through the public chairty to the 
recipient organization, such amount will retain its character as a 
contribution from such donor and, if, for example, the donor is a 
substantial contributor (as defined in section 507(d)(2)) with respect 
to the ultimate recipient, such amount shall be excluded from the 
numerator of the support fraction under section 509(a)(2). If a public 
charity makes both an indirect contribution from its donor and an 
additional grant to the ultimate recipient, the indirect contribution 
shall be treated as made first.
    (2) Indirect contributions. For purposes of subparagraph (1) of this 
paragraph, an indirect contribution is one which is expressly or 
impliedly ear-marked by the donor as being for, or for the benefit of, a 
particular recipient (rather than for a particular purpose).
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a national foundation for the encouragement of the 
musical arts, is an organization described in section 170(b)(1)(A)(vi). 
A gives M a donation of $5,000 without imposing any restrictions or 
conditions upon the gift. M subsequently makes a $5,000 grant to X, an 
organization devoted to giving public performances of chamber music. 
Since the grant to X is treated as being received from M, it is fully 
includible in the numerator of X's support fraction for the taxable year 
of receipt.
    Example 2. Assume M is the same organization described in example 1. 
B gives M a donation of $10,000, but requires that M spend the money for 
the purpose of supporting organizations devoted to the advancement of 
contemporary American music. M has complete discretion as to the 
organizations of the type described to which it will make a grant. M 
decides to make grants of $5,000 each to Y and Z, both being 
organizations described in section 501(c)(3) and devoted to furthering 
contemporary American music. Since the grants to Y and Z are treated as 
being received from M, Y and Z may each include one of the $5,000 grants 
in the numerator of its support fraction for purposes of section 
509(a)(2)(A). Although the donation to M was conditioned upon the use of 
the funds for a particular purpose, M was free to select the ultimate 
recipient.
    Example 3. N is a national foundation for the encouragement of art 
and is an organization described in section 170(b)(1)(A)(vi). Grants to 
N are permitted to be earmarked for particular purposes. O, which is an 
art workshop devoted to training young artists and claiming status under 
section 509(a)(2), persuades C, a private foundation, to make a

[[Page 136]]

grant of $25,000 to N. C is a disqualified person with respect to O. C 
made the grant to N with the understanding that N would be bound to make 
a grant to O in the sum of $25,000, in addition to a matching grant of 
N's funds to O in the sum of $25,000. Only the $25,000 received directly 
from N is considered a grant from N. The other $25,000 is deemed an 
indirect contribution from C to O and is to be excluded from the 
numerator of O's support fraction.

    (k) Method of accounting. For purposes of section 509(a)(2), an 
organization's support will be determined solely on the cash receipts 
and disbursement method of accounting described in section 446(c)(1). 
For example, if a grantor makes a grant to an organization payable over 
a term of years, such grant will be includible in the support fraction 
of the grantee organization only when and to the extent amounts payable 
under the grant are received by the grantee.
    (l) Gross receipts from section 513(a) (1), (2), or (3) activities. 
For purposes of section 509(a)(2)(A)(ii), gross receipts from activities 
described in section 513(a) (1), (2), or (3) will be considered gross 
receipts from activities which are not unrelated trade or business.
    (m) Gross receipts distinguished from gross investment income. (1) 
For purposes of section 509(a)(2), where the charitable purpose of an 
organization described in section 501(c)(3) is accomplished through the 
furnishing of facilities for a rental fee or loans to a particular class 
of persons, such as aged, sick, or needy persons, the support received 
from such persons will be considered gross receipts (within the meaning 
of section 509(d)(2)) from an activity which is not an unrelated trade 
or business, rather than gross investment income. However, if such 
organization also furnishes facilities or loans to persons who are not 
members of such class and such furnishing does not contribute 
importantly to the accomplishment of such organization's exempt purposes 
(aside from the need of such organization for income or funds or the use 
it makes of the profits derived), the support received from such 
furnishing will be considered rents or interest and therefore will be 
treated as gross investment income within the meaning of section 
509(d)(4), unless such income is included in computing the tax imposed 
by section 511.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. X, an organization described in section 501(c)(3), is 
organized and operated to provide living facilities for needy widows of 
deceased servicemen. X charges such widows a small rental fee for the 
use of such facilities. Since X is accomplishing its exempt purpose 
through the rental of such facilities, the support received from the 
widows is considered gross receipts within the meaning of section 
509(d)(2). However, if X rents part of its facilities to persons having 
no relationship to X's exempt purpose, the support received from such 
rental will be considered gross investment income within the meaning of 
section 509(d)(4), unless such income is included in computing the tax 
imposed by section 511.
    (n) Effective/applicability date. This section shall apply to 
taxable years beginning after December 31, 1969. The applicability of 
paragraphs (a)(2), (a)(3)(i), (c), (d), (e) and (k) of this section 
shall be limited to taxable years beginning before January 1, 2008.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 
37889, July 23, 1981; T.D. 8423, 57 FR 33443, July 29, 1992; T.D. 8991, 
67 FR 20437, Apr. 25, 2002; T.D. 9423, 73 FR 52549, Sept. 9, 2008]



Sec. 1.509(a)-3T  Broadly, publicly supported organizations (temporary).

    (a)(1) [Reserved] For further guidance see Sec. 1.509(a)-3(a)(1).
    (2) One-third support test. An organization will meet the one-third 
support test if it normally (within the meaning of paragraph (c) or (d) 
of this section) receives more than one-third of its support in each 
taxable year from any combination of--
    (i) Gifts, grants, contributions, or membership fees; and
    (ii) Gross receipts from admissions, sales of merchandise, 
performance of services, or furnishing of facilities, in an activity 
that is not an unrelated trade or business (within the meaning of 
section 513), subject to certain limitations described in paragraph (b) 
of this section, from permitted sources. For purposes of this section, 
governmental units, organizations described in section 509(a)(1) and 
persons other than disqualified persons with respect to the organization 
shall be referred to

[[Page 137]]

as permitted sources. For purposes of this section, the amount of 
support received from the sources described in paragraph (a)(2)(i) of 
this section and this paragraph (a)(2)(ii) (subject to the limitations 
referred to in this paragraph (a)(2)) will be referred to as the 
numerator of the one-third support fraction, and the total amount of 
support received (as defined in section 509(d)) will be referred to as 
the denominator of the one-third support fraction. For purposes of 
section 509(a)(2), Sec. 1.509(a)-3(f) distinguishes gifts and 
contributions from gross receipts; Sec. 1.509(a)-3(g) distinguishes 
grants from gross receipts; Sec. 1.509(a)-3(h) defines membership fees; 
Sec. 1.509(a)-3(i) defines ``any bureau or similar agency of a 
governmental unit''; Sec. 1.509(a)-3(j) describes the treatment of 
certain indirect forms of support; paragraph (k) of this section 
describes the method of accounting for support; Sec. 1.509(a)-3(l) 
describes the treatment of gross receipts from section 513(a)(1), (2), 
or (3) activities; and Sec. 1.509(a)-3(m) distinguishes gross receipts 
from gross investment income.
    (3) Not-more-than-one-third support test--(i) In general. An 
organization will meet the not-more-than-one-third support test under 
section 509(a)(2)(B) if it normally (within the meaning of paragraph (c) 
or (d) of this section) receives not more than one-third of its support 
in each taxable year from the sum of its gross investment income (as 
defined in section 509(e)) and the excess (if any) of the amount of its 
unrelated business taxable income (as defined in section 512) derived 
from trades or businesses that were acquired by the organization after 
June 30, 1975, over the amount of tax imposed on such income by section 
511. For purposes of this section the amount of support received from 
items described in section 509(a)(2)(B) will be referred to as the 
numerator of the not-more-than-one-third support fraction, and the total 
amount of support (as defined in section 509(d)) will be referred to as 
the denominator of the not-more-than-one-third support fraction. For 
purposes of section 509(a)(2), paragraph (m) of this section 
distinguishes gross receipts from gross investment income. For purposes 
of section 509(e), gross investment income includes the items of 
investment income described in Sec. 1.512(b)-1(a).
    (a)(3)(ii) through (b) [Reserved] For further guidance, see Sec. 
1.509(a)-3(a)(3)(ii) through (b).
    (c) Normally--(1) In general--(i) Definition. The support tests set 
forth in section 509(a)(2) are to be computed on the basis of the nature 
of the organization's normal sources of support. An organization will be 
considered as normally receiving one third of its support from any 
combination of gifts, grants, contributions, membership fees, and gross 
receipts from permitted sources (subject to the limitations described in 
Sec. 1.509(a)-3(b)) and not more than one third of its support from 
items described in section 509(a)(2)(B) for its current taxable year and 
the taxable year immediately succeeding its current year, if, for the 
current taxable year and the four taxable years immediately preceding 
the current taxable year, the aggregate amount of the support received 
during the applicable period from gifts, grants, contributions, 
membership fees, and gross receipts from permitted sources (subject to 
the limitations described in Sec. 1.509(a)-3(b)) is more than one 
third, and the aggregate amount of the support received from items 
described in section 509(a)(2)(B) is not more than one third, of the 
total support of the organization for such 5-year period.
    (ii) First five years of an organization's existence. See paragraph 
(d)(1) of this section for the definition of ``normally'' for 
organizations in the first five years of their existence.
    (2) Terminations under section 507(b)(1)(B). For the special rules 
applicable to the term normally as applied to private foundations that 
elect to terminate their private foundation status pursuant to the 60-
month procedure provided in section 507(b)(1)(B), see the regulations 
under such section.
    (3) Exclusion of unusual grants. For purposes of applying the 5-year 
aggregation test for support set forth in paragraph (c)(1) of this 
section, one or more contributions may be excluded from the numerator of 
the one-third support fraction and from the denominator of both the one-
third support and not-more-than-one-third support fractions only if such 
a contribution meets

[[Page 138]]

the requirements of this paragraph (c)(3). The exclusion provided by 
this paragraph (c)(3) is generally intended to apply to substantial 
contributions and bequests from disinterested parties, which 
contributions or bequests--
    (i) Are attracted by reason of the publicly supported nature of the 
organization;
    (ii) Are unusual or unexpected with respect to the amount thereof; 
and
    (iii) Would by reason of their size, adversely affect the status of 
the organization as normally meeting the one-third support test for any 
of the applicable periods described in this paragraph (c) or paragraph 
(d) of this section. In the case of a grant (as defined in Sec. 
1.509(a)-3(g)) that meets the requirements of this paragraph (c)(3), if 
the terms of the granting instrument (whether executed before or after 
1969) require that the funds be paid to the recipient organization over 
a period of years, the amount received by the organization each year 
pursuant to the terms of such grant may be excluded for such year. 
However, no item described in section 509(a)(2)(B) may be excluded under 
this paragraph (c)(3). The provisions of this paragraph (c)(3) shall 
apply to exclude unusual grants made during any of the applicable 
periods described in this paragraph (c) or paragraph (d) of this 
section. See paragraph (c)(5)(ii) of this section as to reliance by a 
grantee organization upon an unusual grant ruling under this paragraph 
(c)(3).
    (4) Determining factors. In determining whether a particular 
contribution may be excluded under paragraph (c)(3) of this section, all 
pertinent facts and circumstances will be taken into consideration. No 
single factor will necessarily be determinative. Among the factors to be 
considered are--
    (i) Whether the contribution was made by any person (or persons 
standing in a relationship to such person which is described in section 
4946(a)(1)(C) through (G)) who created the organization, previously 
contributed a substantial part of its support or endowment, or stood in 
a position of authority, such as a foundation manager (within the 
meaning of section 4946(b)), with respect to the organization. A 
contribution made by a person other than those persons described in this 
paragraph (c)(4)(i) will ordinarily be given more favorable 
consideration than a contribution made by a person described in this 
paragraph (c)(4)(i);
    (ii) Whether the contribution was a bequest or an inter vivos 
transfer. A bequest will ordinarily be given more favorable 
consideration than an inter vivos transfer;
    (iii) Whether the contribution was in the form of cash, readily 
marketable securities, or assets which further the exempt purposes of 
the organization, such as a gift of a painting to a museum;
    (iv) Except in the case of a new organization, whether, prior to the 
receipt of the particular contribution, the organization has carried on 
an actual program of public solicitation and exempt activities and has 
been able to attract a significant amount of public support;
    (v) Whether the organization may reasonably be expected to attract a 
significant amount of public support subsequent to the particular 
contribution. In this connection, continued reliance on unusual grants 
to fund an organization's current operating expenses (as opposed to 
providing new endowment funds) may be evidence that the organization 
cannot reasonably be expected to attract future support from the general 
public;
    (vi) Whether, prior to the year in which the particular contribution 
was received, the organization met the one-third support test described 
in paragraph (c)(1) of this section without the benefit of any 
exclusions of unusual grants pursuant to paragraph (c)(3) of this 
section;
    (vii) Whether neither the contributor nor any person standing in a 
relationship to such contributor which is described in section 
4946(a)(1)(C) through (G) continues directly or indirectly to exercise 
control over the organization;
    (viii) Whether the organization has a representative governing body 
as described in Sec. 1.509(a)-3(d)(3)(i); and
    (ix) Whether material restrictions or conditions (within the meaning 
of Sec. 1.507-2T(a)(7)) have been imposed by the transferor upon the 
transferee in connection with such transfer.

[[Page 139]]

    (5) Grantors and contributors. Prior to the making of any grant or 
contribution expected to meet the requirements for exclusion under 
paragraph (c)(3) of this section, a potential grantee organization may 
request a ruling whether such grant or contribution may be so excluded. 
Requests for such ruling may be filed by the grantee organization. The 
issuance of such determination will be at the sole discretion of the 
Commissioner. The organization must submit all information necessary to 
make a determination of the applicability of paragraph (c)(3) of this 
section, including all information relating to the factors described in 
paragraph (c)(4) of this section. If a favorable ruling is issued, such 
ruling may be relied upon by the grantor or contributor of the 
particular contribution in question for purposes of sections 170, 507, 
545(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522 and by the 
grantee organization for purposes of paragraph (c)(3) of this section.
    (6) Examples. The application of the principles set forth in this 
paragraph are illustrated by the examples as follows. For purposes of 
these examples, the term general public is defined as persons other than 
disqualified persons and other than persons from whom the foundation 
received gross receipts in excess of the greater of $5,000 or 1 percent 
of its support in any taxable year, the term gross investment income is 
as defined in section 509(e), and the term gross receipts is limited to 
receipts from activities which are not unrelated trades or businesses 
(within the meaning of section 513).

    Example 1. (i) For the years 2008 through 2012, X, an organization 
exempt under section 501(c)(3) that makes scholarship grants to needy 
students of a particular city, received support from the following 
sources:

2008:
  Gross receipts (general public)...........................     $35,000
  Contributions (substantial contributors)..................      36,000
  Gross investment income...................................      29,000
                                                             -----------
    Total support...........................................     100,000
2009:
  Gross receipts (general public)...........................      34,000
  Contributions (substantial contributors)..................      35,000
  Gross investment income...................................      31,000
                                                             -----------
    Total support...........................................     100,000
2010:
  Gross receipts (general public)...........................      35,000
  Contributions (substantial contributors)..................      30,000
  Gross investment income...................................      35,000
                                                             -----------
    Total support...........................................     100,000
2011:
  Gross receipts (general public)...........................      33,000
  Contributions (substantial contributors)..................      32,000
  Gross investment income...................................      35,000
                                                             -----------
    Total support...........................................     100,000
2012:
  Gross receipts (general public)...........................      31,000
  Contributions (substantial contributors)..................      39,000
  Gross investment income...................................      30,000
                                                             -----------
    Total support...........................................    $100,000
 

    (ii) In applying section 509(a)(2) to the taxable year 2012, on the 
basis of paragraph (c)(1)(i) of this section, the total amount of 
support from gross receipts from the general public ($168,000) for the 
period 2008 through 2012, was more than one third, and the total amount 
of support from gross investment income ($160,000) was less than one 
third, of X's total support for the same period ($500,000). For the 
taxable years 2012 and 2013, X is therefore considered normally to 
receive more than one third of its support from the public sources 
described in section 509(a)(2)(A) and less than one third of its support 
from items described in section 509(a)(2)(B). The fact that X received 
less than one third of its support from section 509(a)(2)(A) sources in 
2012 and more than one third of its support from items described in 
section 509(a)(2)(B) in 2011 does not affect its status because it met 
the normally test over a 5-year period.
    Example 2. Assume the same facts as in Example 1 except that in 
2012, X also received an unexpected bequest of $50,000 from A, an 
elderly widow who was interested in encouraging the work of X, but had 
no other relationship to it. Solely by reason of the bequest, A became a 
disqualified person. X used

[[Page 140]]

the bequest to create 5 new scholarships. Its operations otherwise 
remained the same. Under these circumstances X could not meet the 5-year 
support test because the total amount received from gross receipts from 
the general public ($168,000) would not be more than one-third of its 
total support for the 5-year period ($550,000). Because A is a 
disqualified person, her bequest cannot be included in the numerator of 
the one-third support test under section 509(a)(2)(A). However, based on 
the factors set forth in paragraph (c)(4) of this section, A's bequest 
may be excluded as an unusual grant under paragraph (c)(3) of this 
section. Therefore, X will be considered to have met the support test 
for the taxable years 2012 and 2013.
    Example 3. Y, an organization described in section 501(c)(3), was 
created by A, the holder of all the common stock in M corporation, B, 
A's wife, and C, A's business associate. The purpose of Y was to sponsor 
and equip athletic teams for underprivileged children in the community. 
Each of the three creators makes small cash contributions to Y. A, B, 
and C have been active participants in the affairs of Y since its 
creation. Y regularly raises small amounts of contributions through 
fundraising drives and selling admission to some of the sponsored 
sporting events. The operations of Y are carried out on a small scale, 
usually being restricted to the sponsorship of two to four baseball 
teams of underprivileged children. In 2009, M recapitalizes and creates 
a first and second class of 6 percent nonvoting preferred stock, most of 
which is held by A and B. In 2010, A contributes 49 percent of his 
common stock in M to Y. A's contribution of M's common stock was 
substantial and constitutes 90 percent of Y's total support for 2010. A 
combination of the facts and circumstances described in paragraph (c)(4) 
of this section preclude A's contribution of M's common stock in 2010 
from being excluded as an unusual grant under paragraph (c)(3) of this 
section for purposes of determining whether Y meets the one-third 
support test under section 509(a)(2).
    Example 4. (i) M is organized in 2009 to promote the appreciation of 
ballet in a particular region of the United States. Its principal 
activities consist of erecting a theater for the performance of ballet 
and the organization and operation of a ballet company. M receives a 
determination letter that it is an organization described in section 
501(c)(3) and that it is a public charity described in section 
509(a)(2). The governing body of M consists of 9 prominent unrelated 
citizens residing in the region who have either an expertise in ballet 
or a strong interest in encouraging appreciation of the art form.
    (ii) In 2010, Z, a private foundation, proposes to makes a grant of 
$500,000 in cash to M to provide sufficient capital for M to commence 
its activities. Although A, the creator of Z, is one of the nine members 
of M's governing body, was one of M's original founders, and continues 
to lend his prestige to M's activities and fund raising efforts, A does 
not, directly or indirectly, exercise any control over M. M also 
receives a significant amount of support from a number of smaller 
contributions and pledges from other members of the general public. M 
charges admission to the ballet performances to the general public.
    (iii) Although the support received in 2010 will not impact M's 
status as a public charity for its first 5 taxable years, it will be 
relevant to the determination of whether M meets the one-third support 
test under section 509(a)(2) for the 2014 taxable year, using the 
computation period 2010 through 2014. Within the appropriate timeframe, 
M may submit a request for a private letter ruling that the $500,000 
contribution from Z qualifies as an unusual grant.
    (iv) Under the above circumstances, even though A was a founder and 
member of the governing body of M, M may exclude Z's contribution of 
$500,000 in 2010 as an unusual grant under paragraph (c)(3) of this 
section for purposes of determining whether M meets the one-third 
support test under section 509(a)(2) for 2014.
    Example 5. (i) Assume the same facts as Example 4. In 2013, B, a 
widow, passes away and bequeaths $4 million to M. During 2009 through 
2013, B made small contributions to M, none exceeding $10,000 in any 
year. During 2009 through 2013, M received approximately $550,000 from 
receipts for admissions and contributions from the general public. At 
the time of B's death, no person standing in a relationship to B 
described in section 4946(a)(1)(C) through (G) was a member of M's 
governing body. B's bequest was in the form of cash and readily 
marketable securities. The only condition placed upon the bequest was 
that it be used by M to advance the art of ballet.
    (ii) Although the support received in 2013 will not impact M's 
status as a public charity for its first five taxable years, it will be 
relevant to the determination of whether M meets the one-third support 
test under section 509(a)(2) for future years. Within the appropriate 
timeframe, M may submit a request for a private letter ruling that the 
$4 million bequest from B qualifies as an unusual grant.
    (iii) Under the above circumstances, M may exclude B's bequest of $4 
million in 2013 as an unusual grant under paragraph (c)(3) of this 
section for purposes of determining whether M meets the one-third 
support test under section 509(a)(2) for 2014 and subsequent years.
    Example 6. (i) N is a research organization that was created by A in 
2009 for the purpose of carrying on economic studies primarily through 
persons receiving grants from N and

[[Page 141]]

engaging in the sale of economic publications. N received a 
determination letter that it is described in section 501(c)(3) and that 
it is a public charity described in 509(a)(2). N's five-member governing 
body consists of A, A's sons, B and C, and two unrelated economists. In 
2009, A made a contribution to N of $100,000 to help establish the 
organization. During 2009 through 2013, A made annual contributions to N 
averaging $20,000 a year. During the same period, N received annual 
contributions from members of the general public averaging $15,000 per 
year and receipts from the sale of its publications averaging $50,000 
per year. In 2013, B made an inter vivos contribution to N of $600,000 
in cash and readily marketable securities.
    (ii) Although the support received in 2013 will not impact N's 
status as a public charity for its first 5 taxable years, it will be 
relevant to the determination of whether N meets the one-third support 
test under section 509(a)(2) for future years. In determining whether 
B's contribution of $600,000 in 2013 may be excluded as an unusual 
grant, the support N received in 2009 through 2013 is relevant in 
considering the factor described in paragraph (c)(4)(vi) of this 
section, notwithstanding that N received a determination letter that it 
is described in section 509(a)(2).
    (iii) Based on the application of the factors in paragraphs 
(c)(4)(i) through (ix) of this section to N's circumstances, in 
particular the facts that B is a disqualified person described in 
section 4946(a)(1)(D) and N does not have a representative governing 
body as described in paragraphs (c)(4)(viii) and (d)(3)(i) of this 
section, N cannot exclude B's contribution of $600,000 in 2013 as an 
unusual grant under paragraph (c)(3) of this section for purposes of 
determining whether N meets the one-third support test under section 
509(a)(2) for 2014 and future years.
    Example 7. (i) O is an educational organization created in 2009. O 
received a determination letter that it is described in section 
501(c)(3) and that it is a public charity described in section 
509(a)(2). The governing body of O has 9 members, consisting of A, a 
prominent civic leader and 8 other unrelated civic leaders and educators 
in the community, all of whom participated in the creation of O. During 
2009 through 2013, the principal source of income for O has been 
receipts from the sale of its educational periodicals. These sales have 
amounted to $200,000 for this period. Small contributions amounting to 
$50,000 have also been received during the same period from members of 
the governing body, including A, as well as other members of the general 
public.
    (ii) In 2013, A contributed $750,000 of the nonvoting stock of S, a 
closely held corporation, to O. A retained a substantial portion of the 
voting stock of S. By a majority vote, the governing body of O decided 
to retain the S stock for a period of at least 5 years.
    (iii) Although the support received in 2013 will not impact O's 
status as a public charity for its first 5 taxable years, it will be 
relevant to the determination of whether O meets the one-third support 
test under section 509(a)(2) for future years. In determining whether 
A's contribution of the S stock in 2013 may be excluded as an unusual 
grant, the support O received in 2009 through 2013 is relevant in 
considering the factor described in paragraph (c)(4)(vi) of this 
section, notwithstanding that O received a determination letter that it 
is described in section 509(a)(2).
    (iv) Based on the application of the factors in paragraphs (c)(4)(i) 
through (ix) of this section to O's circumstances, in particular the 
facts that A is a foundation manager within the meaning of section 
4946(b) and A's contribution is in the form of closely held stock, O 
cannot exclude A's contribution of the S stock in 2013 as an unusual 
grant under paragraph (c)(3) of this section for purposes of determining 
whether O meets the one-third support test under section 509(a)(2) for 
2014 and future years.

    (d) Definition of normally--first five years of an organization's 
existence--(1) In general. An organization meets the one-third support 
test and the not-more-than-one-third support test during its first five 
taxable years as a section 501(c)(3) organization if the organization 
can reasonably be expected to meet the requirements of the one-third 
support test and the not-more-than-one-third support test during that 
period. With respect to such organization's sixth taxable year, the 
organization shall be described in section 509(a)(2) if it meets the 
one-third support test and the not-more-than-one-third support test 
under the definition of normally set forth in paragraph (c)(1)(i) of 
this section for its sixth taxable year (based on support received in 
its second through sixth taxable years), or for its fifth taxable year 
(based on support received in its first through fifth taxable years).
    (2) Basic consideration. In determining whether an organization can 
reasonably be expected (within the meaning of paragraph (c)(1)(i) of 
this section) to meet the one-third support test under section 
509(a)(2)(A) and the not-more-than-one-third support test under section 
509(a)(2)(B) described in paragraph (c) of this section during its first 
5 taxable years, the basic consideration is whether its organizational 
structure,

[[Page 142]]

current or proposed programs or activities, and actual or intended 
method of operation are such as to attract the type of broadly based 
support from the general public, public charities, and governmental 
units that is necessary to meet such tests. The factors that are 
relevant to this determination, and the weight accorded to each of them, 
may differ from case to case, depending on the nature and functions of 
the organization. An organization cannot reasonably be expected to meet 
the one-third support test and the not-more-than-one-third support test 
where the facts indicate that an organization is likely during its first 
five taxable years to receive less than one-third of its support from 
permitted sources (subject to the limitations of paragraph (b) of this 
section) or to receive more than one-third of its support from items 
described in section 509(a)(2)(B).
    (3) Factors taken into account. All pertinent facts and 
circumstances shall be taken into account under paragraph (d)(2) of this 
section in determining whether the organizational structure, programs or 
activities, and method of operation of an organization are such as to 
enable it to meet the tests under section 509(a)(2) during its first 
five taxable years. Some of the pertinent factors are:
    (i) Whether the organization has or will have a governing body which 
is comprised of public officials, or individuals chosen by public 
officials acting in their capacity as such, of persons having special 
knowledge in the particular field or discipline in which the 
organization is operating, of community leaders, such as elected 
officials, clergymen, and educators, or, in the case of a membership 
organization, of individuals elected pursuant to the organization's 
governing instrument or bylaws by a broadly based membership. This 
characteristic does not exist if the membership of the organization's 
governing body is such as to indicate that it represents the personal or 
private interests of disqualified persons, rather than the interests of 
the community or the general public.
    (ii) Whether a substantial portion of the organization's initial 
funding is to be provided by the general public, by public charities, or 
by government grants, rather than by a limited number of grantors or 
contributors who are disqualified persons with respect to the 
organization. The fact that the organization plans to limit its 
activities to a particular community or region or to a special field 
which can be expected to appeal to a limited number of persons will be 
taken into consideration in determining whether those persons providing 
the initial support for the organization are representative of the 
general public. On the other hand, the subsequent sources of funding 
which the organization can reasonably expect to receive after it has 
become established and fully operational will also be taken into 
account.
    (iii) Whether a substantial proportion of the organization's initial 
funds are placed, or will remain, in an endowment, and whether the 
investment of such funds is unlikely to result in more than one-third of 
its total support being received from items described in section 
509(a)(2)(B).
    (iv) In the case of an organization that carries on fundraising 
activities, whether the organization has developed a concrete plan for 
solicitation of funds from the general public on a community or area-
wide basis; whether any steps have been taken to implement such plan; 
whether any firm commitments of financial or other support have been 
made to the organization by civic, religious, charitable, or similar 
groups within the community; and whether the organization has made any 
commitments to, or established any working relationships with, those 
organizations or classes of persons intended as the future recipients of 
its funds.
    (v) In the case of an organization that carries on community 
services, such as combating community deterioration in an economically 
depressed area that has suffered a major loss of population and jobs, 
whether the organization has a concrete program to carry out its work in 
the community; whether any steps have been taken to implement that 
program; whether it will receive any part of its funds from a public 
charity or governmental agency to which it is in some way held 
accountable as a condition of the grant

[[Page 143]]

or contribution; and whether it has enlisted the sponsorship or support 
of other civic or community leaders involved in community service 
programs similar to those of the organization.
    (vi) In the case of an organization that carries on educational or 
other exempt activities for, or on behalf of, members, whether the 
solicitation for dues-paying members is designed to enroll a substantial 
number of persons in the community, area, profession, or field of 
special interest (depending on the size of the area and the nature of 
the organization's activities); whether membership dues for individual 
(rather than institutional) members have been fixed at rates designed to 
make membership available to a broad cross-section of the public rather 
than to restrict membership to a limited number of persons; and whether 
the activities of the organization will be likely to appeal to persons 
having some broad common interest or purpose, such as educational 
activities in the case of alumni associations, musical activities in the 
case of symphony societies, or civic affairs in the case of parent-
teacher associations.
    (vii) In the case of an organization that provides goods, services, 
or facilities, whether the organization is or will be required to make 
its services, facilities, performances, or products available 
(regardless of whether a fee is charged) to the general public, public 
charities, or governmental units, rather than to a limited number of 
persons or organizations; whether the organization will avoid executing 
contracts to perform services for a limited number of firms or 
governmental agencies or bureaus; and whether the service to be provided 
is one which can be expected to meet a special or general need among a 
substantial portion of the general public.
    (4) Example. The application of this paragraph (d) may be 
illustrated by the following example:

    Example. (i) Organization X was formed in January 2008 and uses a 
December 31 taxable year. After September 9, 2008, and before December 
31, 2008, Organization X filed Form 1023 requesting recognition of 
exemption as an organization described in section 501(c)(3) and in 
section 509(a)(2). In its application, Organization X established that 
it can reasonably be expected to operate as a public charity under this 
paragraph (d). Subsequently, Organization X received a ruling or 
determination letter that it is an organization described in sections 
501(c)(3) and 509(a)(2) effective as of the date of its formation.
    (ii) Organization X is described in section 509(a)(2) for its first 
5 taxable years (for the taxable years ending December 31, 2008, through 
December 31, 2012).
    (iii) Organization X can qualify as a public charity beginning with 
the taxable year ending December 31, 2013, if Organization X can meet 
the requirements of Sec. 1.170A-9T(f)(4)(i) through (iii) or paragraphs 
(a) through (b) of this section for the taxable years ending December 
31, 2009, through December 31, 2013, or for the taxable years ending 
December 31, 2008, through December 31, 2012.

    (e) Determinations on foundation classification and reliance. (1) A 
ruling or determination letter that an organization is described in 
section 509(a)(2) may be issued to an organization. Such determination 
may be made in conjunction with the recognition of the organization's 
tax-exempt status or at such other time as the organization believes it 
is described in section 509(a)(2). The ruling or determination letter 
that the organization is described in section 509(a)(2) may be revoked 
if, upon examination, the organization has not met the requirements of 
this section. The ruling or determination letter that the organization 
is described in section 509(a)(2) also may be revoked if the 
organization's application for a ruling or determination contained one 
or more material misstatements of fact or such application was part of a 
scheme or plan to avoid or evade any provision of the Internal Revenue 
Code. The revocation of the determination that an organization is 
described in section 509(a)(2) does not preclude revocation of the 
determination that the organization is described in section 501(c)(3).
    (2) Status of grantors or contributors. For purposes of sections 
170, 507, 545(b)(2), 642(c), 4942, 4945, 2055, 2106(a)(2), and 2522, 
grantors and contributors may rely upon a determination letter or ruling 
that an organization is described in section 509(a)(2) until the 
Internal Revenue Service publishes notice of a change of status (for 
example, in the Internal Revenue Bulletin or Publication 78, 
``Cumulative List of Organizations described

[[Page 144]]

in Section 170(c) of the Internal Revenue Code of 1986,'' which can be 
searched at www.irs.gov). For this purpose, grantors or contributors may 
also rely on an advance ruling that expires on or after June 9, 2008. 
However, a grantor or contributor may not rely on such an advance ruling 
or any determination letter or ruling if the grantor or contributor was 
responsible for, or aware of, the act or failure to act that resulted in 
the organization's loss of classification under section 509(a)(2) or 
acquired knowledge that the Internal Revenue Service had given notice to 
such organization that it would be deleted from such classification.
    (3) Examples. The provisions of this paragraph (e) may be 
illustrated by the following examples:

    Example 1. Y, a calendar year organization described in section 
501(c)(3), is created in February 2008 for the purpose of displaying 
African art. On its exemption application Y shows, under penalties of 
perjury, that it can reasonably, in accordance with the requirements of 
paragraph (d) of this section, expect to receive support from the public 
in 2008 through 2012 that will satisfy the one-third support and not-
more-than-one-third support tests described in section 509(a)(2) for its 
first 5 taxable years, 2008 through 2012. Y may therefore receive a 
determination that it meets the requirements of paragraph (a) of this 
section. Pursuant to such determination, Y will be a public charity for 
its first five taxable years (2008, 2009, 2010, 2011, and 2012), 
regardless of the public support Y in fact receives during this period.
    Example 2. Z, a calendar year organization described in section 
501(c)(3), is created in July 2008. On its exemption application Z 
shows, under penalties of perjury, that it can reasonably, in accordance 
with the requirements of paragraph (d) of this section, expect to 
receive support from the public in 2008 through 2012 that will satisfy 
the one-third support and not-more-than-one-third support tests 
described in section 509(a)(2) for its first 5 taxable years, 2008 
through 2012. Z receives a determination that it is described in section 
509(a)(2). However, the support actually received from the public over 
Z's first 5 taxable years (2008 through 2012) does not satisfy the one-
third support and not-more-than-one-third support tests described in 
section 509(a)(2), nor does the support Z receives from 2009 through and 
including its sixth taxable year, 2013, meet the one-third support and 
not-more-than-one-third support tests described in section 509(a)(2). Z 
is described in section 509(a)(2) during its first five years for all 
purposes. But, because Z has not met the requirements of paragraph (a) 
of this section either for 2008 through 2012 or 2009 through 2013, Z is 
not described in section 509(a)(2) for its taxable year 2013. If Z is 
not described in section 509(a)(1), (3), or (4), then Z is a private 
foundation as of 2013, and Z will be treated as a private foundation for 
all purposes (except as provided in paragraph (e)(2) of this section 
with respect to grantors and contributors).

    (f) through (j) [Reserved] For further guidance, see Sec. 1.509(a)-
3(f) through (j).
    (k) Method of accounting. For purposes of section 509(a)(2), an 
organization's support will be determined under the method of accounting 
on the basis of which the organization regularly computes its income in 
keeping its books under section 446. For example, if a grantor makes a 
grant to an organization payable over a term of years, such grant will 
be includible in the support fraction of the grantee organization under 
the method of accounting on the basis of which it regularly computes its 
income in keeping its books under section 446.
    (l) and (m) [Reserved] For further guidance, see Sec. 1.509(a)-3(l) 
and (m).
    (n) Transition rules. (i) An organization that received an advance 
ruling, that expires on or after June 9, 2008, that it will be treated 
as an organization described in sections 170(b)(1)(A)(vi) and 509(a)(1) 
or in section 509(a)(2) will be treated as meeting the requirements of 
paragraph (d)(1) of this section for the first five taxable years of its 
existence as a section 501(c)(3) organization unless the Internal 
Revenue Service issued to the organization a proposed determination 
prior to September 9, 2008, that the organization is not described in 
sections 170(b)(1)(A)(vi) and 509(a)(1) or in section 509(a)(2).
    (ii) Paragraph (d)(1) of this section shall not apply to an 
organization that received an advance ruling that expired prior to June 
9, 2008, and that did not timely file with the Internal Revenue Service 
the required information to establish that it is an organization 
described in sections 170(b)(1)(A)(vi) and 509(a)(1) or in section 
509(a)(2).
    (iii) An organization that fails to meet a public support test for 
its first taxable year beginning on or after January 1, 2008, under the 
regulations in this section may use the prior test set forth in Sec. 
1.509(a)-3(c)(1) or Sec. 1.170A-

[[Page 145]]

9(e)(4)(i) or (ii) as in effect before September 9, 2008, (as contained 
in 26 CFR part 1 revised April 1, 2008) to determine whether the 
organization may be publicly supported for its 2008 taxable year based 
on its satisfaction of a public support test for taxable year 2007, 
computed over the period 2003 through 2006.
    (iv) Examples. The application of this paragraph (n) may be 
illustrated by the following examples:

    Example 1. (i) Organization M was formed in January 2004, and uses a 
June 30 taxable year. Organization M received an advance ruling letter 
that it is recognized as an organization described in section 501(c)(3) 
effective as of the date of its formation and that it is treated as a 
public charity under section 509(a)(2) during the five-year advance 
ruling period that will end on June 30, 2008. This date is within 90 
days before September 9, 2008.
    (ii) Under the transition rule, Organization M is a public charity 
described in section 509(a)(2) for the taxable years ending June 30, 
2004, through June 30, 2008. Organization M does not need to establish 
within 90 days after June 30, 2008, that it met a public support test 
under Sec. 1.170A-9(e) or Sec. 1.509(a)-3, as in effect prior to 
September 9, 2008, (as contained in 26 CFR part 1 revised April 1, 2008) 
for its advance ruling period.
    (iii) Organization M can qualify as a public charity beginning with 
the taxable year ending June 30, 2009, if Organization M can meet the 
requirements of Sec. 1.170A-9T(f)(4)(i) or (ii) or paragraph (c)(1) of 
this section for the taxable years ending June 30, 2005, through June 
30, 2009, or for the taxable years ending June 30, 2004, through June 
30, 2008. In addition, for its taxable year ending June 30, 2009, 
Organization M may qualify as a public charity by availing itself of the 
transition rule contained in paragraph (n)(iii) of this section, which 
looks to support received by M in the taxable years ending June 30, 
2004, through June 30, 2007.
    Example 2. (i) Organization N was formed in January 2000 and uses a 
December 31 taxable year. Organization N received a final determination 
that it was recognized as tax-exempt under section 501(c)(3) and as a 
public charity prior to September 9, 2008.
    (ii) For taxable year 2008, Organization N will qualify as publicly 
supported if it meets the requirements under either Sec. 1.170A-
9T(f)(4)(i) or (ii) or paragraph (c)(1) of this section for the five-
year period January 1, 2004, through December 31, 2008. Organization N 
will also qualify as publicly supported for taxable year 2008 if it 
meets the requirements under either Sec. 1.170A-9(e)(4)(i) or (ii) or 
Sec. 1.509(a)-3(c)(1) as in effect prior to September 9, 2008, (as 
contained in 26 CFR part 1 revised April 1, 2008) for taxable year 2007, 
using the four-year period from January 1, 2003, through December 31, 
2006.

    (o) Effective/applicability date--(1) Effective date. These 
regulations are effective on September 9, 2008.
    (2) Applicability date. The regulations in paragraphs (a)(2), 
(a)(3)(i), (c), (d), (e) and (k) of this section shall apply to taxable 
years beginning on or after January 1, 2008.
    (3) Expiration date. The applicability of this section expires on 
September 8, 2011.

[T.D. 9423, 73 FR 52549, Sept. 9, 2008]



Sec. 1.509(a)-4  Supporting organizations.

    (a) In general. (1) Section 509(a)(3) excludes from the definition 
of private foundation those organizations which meet the requirements of 
subparagraphs (A), (B), and (C) thereof.
    (2) Section 509(a)(3)(A) provides that a section 509(a)(3) 
organization must be organized, and at all times thereafter operated, 
exclusively for the benefit of, to perform the functions of, or to carry 
out the purposes of one or more specified organizations described in 
section 509(a) (1) or (2). Section 509(a)(3)(A) describes the nature of 
the support or benefit which a section 509(a)(3) organization must 
provide to one or more section 509(a) (1) or (2) organizations. For 
purposes of section 509(a)(3)(A), paragraph (b) of this section 
generally describes the organizational and operational tests; paragraph 
(c) of this section describes permissible purposes under the 
organizational test; paragraph (d) of this section describes the 
requirement of supporting or benefiting one or more specified publicly 
supported organizations; and paragraph (e) of this section describes 
permissible beneficiaries and activities under the operational test.
    (3) Section 509(a)(3)(B) provides that a section 509(a)(3) 
organization must be operated, supervised, or controlled by or in 
connection with one or more organizations described in section 509(a) 
(1) or (2). Section 509(a)(3)(B) and paragraph (f) of this section 
describe the nature of the relationship which must exist between the 
section 509(a)(3) and section 509(a) (1) or (2) organizations. For 
purposes of section 509(a)(3)(B),

[[Page 146]]

paragraph (g) of this section defines operated, supervised, or 
controlled by; paragraph (h) of this section defines supervised or 
controlled in connection with; and paragraph (i) of this section defines 
operated in connection with.
    (4) Section 509(a)(3)(C) provides that a section 509(a)(3) 
organization must not be controlled directly or indirectly by 
disqualified persons (other than foundation managers or organizations 
described in section 509(a) (1) or (2)). Section 509(a)(3)(C) and 
paragraph (j) of this section prescribe a limitation on the control over 
the section 509(a)(3) organization.
    (5) For purposes of this section, the term supporting organization 
means either an organization described in section 509(a)(3) or an 
organization seeking section 509(a)(3) status, depending upon its 
context. For purposes of this section, the term publicly supported 
organization means an organization described in section 509(a) (1) or 
(2).
    (b) Organizational and operational tests. (1) Under subparagraph (A) 
of section 509(a)(3), in order to qualify as a supporting organization, 
an organization must be both organized and operated exclusively for the 
benefit of, to perform the functions of, or to carry out the purposes of 
(hereinafter referred to in this section as being organized and operated 
to support or benefit) one or more specified publicly supported 
organizations. If an organization fails to meet either the 
organizational or the operational test, it cannot qualify as a 
supporting organization.
    (2) In the case of supporting organizations created prior to January 
1, 1970, the organizational and operational tests shall apply as of 
January 1, 1970. Therefore, even though the original articles of 
organization did not limit its purposes to those required under section 
509(a)(3)(A) and even though it operated before January 1, 1970, for 
some purpose other than those required under section 509(a)(3)(A), an 
organization will satisfy the organizational and operational tests if, 
on January 1, 1970, and at all times thereafter, it is so constituted as 
to comply with these tests. For the special rules pertaining to the 
application of the organizational and operational tests 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).
    (c) Organizational test--(1) In general. An organization is 
organized exclusively for one or more of the purposes specified in 
section 509(a)(3)(A) only if its articles of organization (as defined in 
Sec. 1.501(c)(3)-1(b)(2)):
    (i) Limit the purposes of such organization to one or more of the 
purposes set forth in section 509(a)(3)(A);
    (ii) Do not expressly empower the organization to engage in 
activities which are not in furtherance of the purposes referred to in 
subdivision (i) of this subparagraph;
    (iii) State the specified publicly supported organizations on whose 
behalf such organization is to be operated (within the meaning of 
paragraph (d) of this section); and
    (iv) Do not expressly empower the organization to operate to support 
or benefit any organization other than the specified publicly supported 
organizations referred to in subdivision (iii) of this subparagraph.
    (2) Purposes. In meeting the organizational test, the organization's 
purposes, as stated in its articles, may be as broad as, or more 
specific than, the purposes set forth in section 509(a)(3)(A). 
Therefore, an organization which, by the terms of its articles, is 
formed for the benefit of one or more specified publicly supported 
organizations shall, if it otherwise meets the other requirements of 
this paragraph, be considered to have met the organizational test. 
Similarly, articles which state that an organization is formed to 
perform the publishing functions of a specified university are 
sufficient to comply with the organizational test. An organization which 
is operated, supervised, or controlled by (within the meaning of 
paragraph (g) of this section) or supervised or controlled in connection 
with (within the meaning of paragraph (h) of this section) one or more 
sections 509(a) (1) or (2) organizations to carry out the purposes of 
such organizations, will be considered as meeting the requirements of 
this paragraph if the purposes set forth in its articles are similar to, 
but no broader

[[Page 147]]

than, the purposes set forth in the articles of its controlling section 
509(a) (1) or (2) organizations. If, however, the organization by which 
it is operated, supervised, or controlled is a publicly supported 
section 501(c) (4), (5), or (6) organization (deemed to be a section 
509(a)(2) organization for purposes of section 509(a)(3) under the 
provisions of section 509(a)), the supporting organization will be 
considered as meeting the requirements of this paragraph if its articles 
require it to carry on charitable, etc., activities within the meaning 
of section 170(c)(2).
    (3) Limitations. An organization is not organized exclusively for 
the purposes set forth in section 509(a)(3)(A) if its articles expressly 
permit it to operate to support or benefit any organization other than 
those specified publicly supported organizations referred to in 
subparagraph (1)(iii) of this paragraph. Thus, for example, an 
organization will not meet the organizational test under section 
509(a)(3)(A) if its articles expressly empower it to pay over any part 
of its income to, or perform any service for, any organization other 
than those publicly supported organizations specified in its articles 
(within the meaning of paragraph (d) of this section). The fact that the 
actual operations of such organization have been exclusively for the 
benefit of the specified publicly supported organizations shall not be 
sufficient to permit it to meet the organizational test.
    (d) Specified organizations--(1) In general. In order to meet the 
requirements of section 509(a)(3)(A), an organization must be organized 
and operated exclusively to support or benefit one or more specified 
publicly supported organizations. The manner in which the publicly 
supported organizations must be specified in the articles for purposes 
of section 509(a)(3)(A) will depend upon whether the supporting 
organization is operated, supervised, or controlled by or supervised or 
controlled in connection with (within the meaning of paragraphs (g) and 
(h) of this section) such organizations or whether it is operated in 
connection with (within the meaning of paragraph (i) of this section) 
such organizations.
    (2) Nondesignated publicly supported organizations; requirements. 
(i) Except as provided in subdivision (iv) of this subparagraph, in 
order to meet the requirements of subparagraph (1) of this paragraph, 
the articles of the supporting organization must designate each of the 
specified organizations by name unless:
    (a) The supporting organization is operated, supervised, or 
controlled by (within the meaning of paragraph (g) of this section), or 
is supervised or controlled in connection with (within the meaning of 
paragraph (h) of this section) one or more publicly supported 
organizations; and
    (b) The articles of organization of the supporting organization 
require that it be operated to support or benefit one or more 
beneficiary organizations which are designated by class or purpose and 
which include:
    (1) The publicly supported organizations referred to in (a) of this 
subdivision (without designating such organizations by name); or
    (2) Publicly supported organizations which are closely related in 
purpose or function to those publicly supported organizations referred 
to in subdivision (i)(a) or this subparagraph (without designating such 
organization by name).
    (ii) If a supporting organization is described in subdivision (i)(a) 
of this subparagraph, it will not be considered as failing to meet the 
requirements of subparagraph (1) of this paragraph that the publicly 
supported organizations be specified merely because its articles of 
organization permit the conditions described in subparagraphs (3) (i), 
(ii), and (iii) and (4)(i) (a) and (b) of this paragraph.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. X is an organization described in section 501(c)(3) which 
operates for the benefit of institutions of higher learning in the State 
of Y. X is controlled by these institutions (within the meaning of 
paragraph (g) of this section) and such institutions are all section 
509(a)(1) organizations. X's articles will meet the organizational test 
if they require X to operate for the benefit of institutions of higher 
learning or educational organizations in the State of Y (without naming 
each institution). X's articles would also meet the organizational test 
if they provided

[[Page 148]]

for the giving of scholarships to enable students to attend institutions 
of higher learning but only in the State of Y.
    Example 2. M is an organization described in section 501(c)(3) which 
was organized and operated by representatives of N church to run a home 
for the aged. M is controlled (within the meaning of paragraph (g) of 
this section) by N church, a section 509(a)(1) organization. The care of 
the sick and the aged are longstanding temporal functions and purposes 
of organized religion. By operating a home for the aged, M is operating 
to support or benefit N church in carrying out one of its temporal 
purposes. Thus M's articles will meet the organizational test if they 
require M to care for the aged since M is operating to support one of N 
church's purposes (without designating N church by name).

    (iv) A supporting organization will meet the requirements of 
subparagraph (1) of this paragraph even though its articles do not 
designate each of the specified organizations by name if:
    (a) There has been an historic and continuing relationship between 
the supporting organization and the section 509(a) (1) or (2) 
organizations, and
    (b) By reason of such relationship, there has developed a 
substantial identity of interests between such organizations.
    (3) Nondesignated publicly supported organizations; scope of rule. 
If the requirements of subparagraph (2)(i) (a) of this paragraph are 
met, a supporting organization will not be considered as failing the 
test of being organized for the benefit of specified organizations 
solely because its articles:
    (i) Permit the substitution of one publicly supported organization 
within a designated class for another publicly supported organization 
either in the same or a different class designated in the articles;
    (ii) Permit the supporting organization to operate for the benefit 
of new or additional publicly supported organizations of the same or a 
different class designated in the articles; or
    (iii) Permit the supporting organization to vary the amount of its 
support among different publicly supported organizations within the 
class or classes of organizations designated by the articles


For example, X is an organization which operates for the benefit of 
private colleges in the State of Y. If X is controlled by these colleges 
(within the meaning of paragraph (g) of this section) and such colleges 
are all section 509(a)(1) organizations, X's articles will meet the 
organization test even if they permit X to operate for the benefit of 
any new colleges created in State Y in addition to the existing colleges 
or in lieu of one which has ceased to operate, or if they permit X to 
vary its support by paying more to one college than to another in a 
particular year.
    (4) Designated publicly supported organizations. (i) If an 
organization is organized and operated to support one or more publicly 
supported organizations and it is operated in connection with such 
organization or organizations, then, except as provided in subparagraph 
(2)(iv) of this paragraph, its articles of organization must, for 
purposes of satisfying the organizational test under section 
509(a)(3)(A), designate the specified organizations by name. Under the 
circumstances described in this subparagraph, a supporting organization 
which has one or more specified organizations designated by name in its 
articles, will not be considered as failing the test of being organized 
for the benefit of specified organizations solely because its articles:
    (a) Permit a publicly supported organization which is designated by 
class or purpose, rather than by name, to be substituted for the 
publicly supported organization or organizations designated by name in 
the articles, but only if such substitution is conditioned upon the 
occurrence of an event which is beyond the control of the supporting 
organization, such as loss of exemption, substantial failure or 
abandonment of operations, or dissolution of the publicly supported 
organization or organizations designated in the articles;
    (b) Permit the supporting organization to operate for the benefit of 
a beneficiary organization which is not a publicly supported 
organization, but only if such supporting organization is currently 
operating for the benefit of a publicly supported organization and the 
possibility of its operating for the benefit of other than a publicly 
supported organization is a remote contingency; or

[[Page 149]]

    (c) Permit the supporting organization to vary the amount of its 
support between different designated organizations, so long as it meets 
the requirements of the integral part test set forth in paragraph (i)(3) 
of this section with respect to at least one beneficiary organization.
    (ii) If the beneficiary organization referred to in subdivision 
(i)(b) of this subparagraph is not a publicly supported organization, 
the supporting organization will not then meet the operational test of 
paragraph (e)(1) of this section. Therefore, if a supporting 
organization substituted in accordance with such subdivision (i)(b) a 
beneficiary other than a publicly supported organization and operated in 
support of such beneficiary organization, the supporting organization 
would not be described in section 509(a)(3).
    (iii) This subparagraph may be illustrated by the following example:

    Example. X is a charitable trust described in section 4947(a)(1) 
organized in 1968. Under the terms of its trust instrument, X's trustees 
are required to pay over all of X's annual income to M University 
Medical School for urological research. If M University Medical School 
is unable or unwilling to devote these funds to urological research, the 
trustees are required to pay all of such income to N University Medical 
School. However if N University Medical School is also unable or 
unwilling to devote these funds to urological research, X's trustees are 
directed to choose a similar organization willing to apply X's funds for 
urological research. From 1968 to 1973, X pays all of its net income to 
M University Medical School pursuant to the terms of the trust. M and N 
are publicly supported organizations. Although the contingent 
remainderman may not be a publicly supported organization, the 
possibility that X may operate for the benefit of other than a publicly 
supported organization is, in 1973, a remote possibility, and X will be 
considered as operating for the benefit of a specified publicly 
supported organization under subdivision (i)(b) of this subparagraph. 
However, if, at some future date, X actually substituted a nonpublicly 
supported organization as beneficiary, X would fail the requirements of 
the operational test set forth in paragraph (e)(1) of this section.

    (e) Operational test--(1) Permissible beneficiaries. A supporting 
organization will be regarded as operated exclusively to support one or 
more specified publicly supported organizations (hereinafter referred to 
as the operational test) only if it engages solely in activities which 
support or benefit the specified publicly supported organizations. Such 
activities may include making payments to or for the use of, or 
providing services or facilities for, individual members of the 
charitable class benefited by the specified publicly supported 
organization. A supporting organization may also, for example, make a 
payment indirectly through another unrelated organization to a member of 
a charitable class benefited by the specified publicly supported 
organization, but only if such a payment constitutes a grant to an 
individual rather than a grant to an organization. In determining 
whether a grant is indirectly to an individual rather than to an 
organization the same standard shall be applied as in Sec. 53.4945-
4(a)(4) of this chapter. Similarly, an organization will be regarded as 
operated exclusively to support or benefit one or more specified 
publicly supported organizations even if it supports or benefits an 
organization, other than a private foundation, which is described in 
section 501(c)(3) and is operated, supervised, or controlled directly by 
or in connection with such publicly supported organizations, or which is 
described in section 511(a)(2)(B). However, an organization will not be 
regarded as operated exclusively if any part of its activities is in 
furtherance of a purpose other than supporting or benefiting one or more 
specified publicly supported organizations.
    (2) Permissible activities. A supporting organization is not 
required to pay over its income to the publicly supported organizations 
in order to meet the operational test. It may satisfy the test by using 
its income to carry on an independent activity or program which supports 
or benefits the specified publicly supported organizations. All such 
support must, however, be limited to permissible beneficiaries in 
accordance with subparagraph (1) of this paragraph. The supporting 
organization may also engage in fund raising activities, such as 
solicitations, fund raising dinners, and unrelated trade or business to 
raise funds for the publicly supported organizations, or for the 
permissible beneficiaries.

[[Page 150]]

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

    Example 1. M is a separately incorporated alumni association of X 
University and is an organization described in section 501(c)(3). X 
University is designated in M's articles as the sole beneficiary of its 
support. M uses all of its dues and income to support its own program of 
educational activities for alumni, faculty, and students of X University 
and to encourage alumni to maintain a close relationship with the 
university and to make contributions to it. M does not distribute any of 
its income directly to X for the latter's general purposes. M pays no 
part of its funds to, or for the benefit of, any organization other than 
X. Under these circumstances, M is considered as operated exclusively to 
perform the functions and carry out the purpose of X. Although it does 
not pay over any of its funds to X, it carries on a program which both 
supports and benefits X.
    Example 2. N is a separately incorporated religious and educational 
organization described in section 501(c)(3). It was formed and is 
operated by Y Church to provide religious training for the members of 
the church. While it does not maintain a regular faculty, N conducts a 
Sunday school, weekly adult education lectures on religious subjects, 
and other similar activities for the benefit of the church members. All 
of its funds are disbursed in furtherance of such activities and no part 
of its funds is paid to, or for the benefit of, any organization other 
than Y Church. N is considered as operated exclusively to perform the 
educational functions of Y Church and to carry out its religious 
purposes by providing various forms of religious instruction.
    Example 3. P is an organization described in section 501(c)(3). Its 
primary activity is providing financial assistance to S, a publicly 
supported organization which aids underdeveloped nations in Central 
America. P's articles of organization designate S as the principal 
recipient of P's assistance. However, P also makes a small annual 
general purpose grant to T, a private foundation engaged in work similar 
to that carried on by S. T performs a particular function that assists 
in the overall aid program carried on by S. Even though P is operating 
primarily for the benefit of S, a specified publicly supported 
organization, it is not considered as operated exclusively for the 
purposes set forth in section 509(a)(3)(A). The grant to T, a private 
foundation, prevents it from complying with the operational test under 
section 509(a)(3)(A).
    Example 4. Assume the same facts as example 3, except that T is a 
section 501(c)(3) organization other than a private foundation and is 
operated in connection with S. Under these circumstances, P will be 
considered as operated exclusively to support S within the meaning of 
section 509(a)(3)(A).
    Example 5. Assume the same facts as example 3 except that instead of 
the annual general purpose grant made to T, each grant made by P to T is 
specifically earmarked for the training of social workers and teachers, 
designated by name, from Central America. Under these circumstances, P's 
grants to T would be treated as grants to the individual social workers 
and teachers under section 4945(d)(3) and Sec. 53.4945-4(a)(4), rather 
than as grants to T under section 4945(d)(4). These social workers and 
teachers are part of the charitable class benefitted by S. P would thus 
be considered as operating exclusively to support S within the meaning 
of section 509(a)(3)(A).

    (f) Nature of relationship required between organizations--(1) In 
general. Section 509(a)(3)(B) describes the nature of the relationship 
required between a section 501(c)(3) organization and one or more 
publicly supported organizations in order for such section 501(c)(3) 
organization to qualify under the provisions of section 509(a)(3). To 
meet the requirements of section 509(a)(3), an organization must be 
operated, supervised, or controlled by or in connection with one or more 
publicly supported organizations. If an organization does not stand in 
one of such relationships (as provided in this paragraph) to one or more 
publicly supported organizations, it is not an organization described in 
section 509(a)(3).
    (2) Types of relationships. Section 509(a)(3)(B) sets forth three 
different types of relationships, one of which must be met in order to 
meet the requirements of subparagraph (1) of this paragraph. Thus, a 
supporting organization may be:
    (i) Operated, supervised, or controlled by,
    (ii) Supervised or controlled in connection with, or
    (iii) Operated in connection with, one or more publicly supported 
organizations.
    (3) Requirements of relationships. Although more than one type of 
relationship may exist in any one case, any relationship described in 
section 509(a)(3)(B) must insure that:
    (i) The supporting organization will be responsive to the needs of 
demands of one or more publicly supported organizations; and

[[Page 151]]

    (ii) The supporting organization will constitute an integral part 
of, or maintain a significant involvement in, the operations of one or 
more publicly supported organizations.
    (4) General description of relationships. In the case of supporting 
organizations which are operated, supervised, or controlled by one or 
more publicly supported organizations, the distinguishing feature of 
this type of relationship is the presence of a substantial degree of 
direction by the publicly supported organizations over the conduct of 
the supporting organization, as described in paragraph (g) of this 
section. In the case of supporting organizations which are supervised or 
controlled in connection with one or more publicly supported 
organizations, the distinguishing feature is the presence of common 
supervision or control among the governing bodies of all organizations 
involved, such as the presence of common directors, as described in 
paragraph (h) of this section. In the case of a supporting organization 
which is operated in connection with one or more publicly supported 
organizations, the distinguishing feature is that the supporting 
organization is responsive to, and significantly involved in the 
operations of, the publicly supported organization, as described in 
paragraph (i) of this section.
    (g) Meaning of operated, supervised, or controlled by. (1)(i) Each 
of the items operated by, supervised by, and controlled by, as used in 
section 509(a)(3)(B), presupposes a substantial degree of direction over 
the policies, programs, and activities of a supporting organization by 
one or more publicly supported organizations. The relationship required 
under any one of these terms is comparable to that of a parent and 
subsidiary, where the subsidiary is under the direction of, and 
accountable or responsible to, the parent organization. This 
relationship is established by the fact that a majority of the officers, 
directors, or trustees of the supporting organization are appointed or 
elected by the governing body, members of the governing body, officers 
acting in their official capacity, or the membership of one or more 
publicly supported organizations.
    (ii) A supporting organization may be operated, supervised, or 
controlled by one or more publicly supported organizations within the 
meaning of section 509(a)(3)(B) even though its governing body is not 
comprised of representatives of the specified publicly supported 
organizations for whose benefit it is operated within the meaning of 
section 509(a)(3)(A). A supporting organization may be operated, 
supervised, or controlled by one or more publicly supported 
organizations (within the meaning of section 509(a)(3)(B)) and be 
operated for the benefit of one or more different publicly supported 
organizations (within the meaning of section 509(a)(3)(A)) only if it 
can be demonstrated that the purposes of the former organizations are 
carried out by benefitting the latter organizations.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. X is a university press which is organized and operated 
as a nonstock educational corporation to perform the publishing and 
printing for M University, a publicly supported organization. Control of 
X is vested in a Board of Governors appointed by the Board of Trustees 
of M University upon the recommendation of the president of the 
university. X is considered to be operated, supervised, or controlled by 
M University within the meaning of section 509(a)(3)(B).
    Example 2. Y Council was organized under the joint sponsorship of 
seven independent publicly supported organizations, each of which is 
dedicated to the advancement of knowledge in a particular field of 
social science. The sponsoring organizations organized Y Council as a 
means of pooling their ideas and resources for the attainment of common 
objectives, including the conducting of scholarly studies and formal 
discussions in various fields of social science. Under Y Council's by-
laws, each of the seven sponsoring organizations elects three members to 
Y's board of trustees for 3-year terms. Y's board also includes the 
president of Y Council and eight other individuals elected at large by 
the board. Pursuant to policies established or approved by the board, Y 
Council engages in research, planning, and evaluation in the social 
sciences and sponsors or arranges conferences, seminars, and similar 
programs for scholars and social scientists. It carries out these 
activities through its own full-time professional staff, through a part-
time committee of scholars, and through grant recipients. Under the 
above circumstances, Y Council is subject to

[[Page 152]]

a substantial degree of direction by the sponsoring publicly supported 
organizations. It is therefore considered to be operated, supervised, or 
controlled by such sponsoring organizations within the meaning of 
section 509(a)(3)(B).
    Example 3. Z is a charitable trust created by A in 1972. It has 
three trustees, all of whom are appointed by M University, a publicly 
supported organization. The trust was organized and is operated to pay 
over all of its net income for medical research to N, O, and P, each of 
which is specified in the trust, is a hospital described in section 
509(a)(1), and is located in the same city as M. Members of M's biology 
department are permitted to use the research facilities of N, O, and P. 
Under subparagraph (1)(ii) of this paragraph, Z is considered to be 
operated, supervised, or controlled by M within the meaning of section 
509(a)(3)(B), even though it is operated for the benefit of N, O, and P 
within the meaning of section 509(a)(3)(A).

    (h) Meaning of supervised or controlled in connection with. (1) In 
order for a supporting organization to be supervised or controlled in 
connection with one or more publicly supported organizations, there must 
be common supervision or control by the persons supervising or 
controlling both the supporting organization and the publicly supported 
organizations to insure that the supporting organization will be 
responsive to the needs and requirements of the publicly supported 
organizations. Therefore, in order to meet such requirement, the control 
or management of the supporting organization must be vested in the same 
persons that control or manage the publicly supported organizations.
    (2) A supporting organization will not be considered to be 
supervised or controlled in connection with one or more publicly 
supported organizations if such organization merely makes payments 
(mandatory or discretionary) to one or more named publicly supported 
organizations, even if the obligation to make payments to the named 
beneficiaries is enforceable under State law by such beneficiaries and 
the supporting organization's governing instrument contains provisions 
whose effect is described in section 508(e)(1) (A) and (B). Such 
arrangements do not provide a sufficient connection between the payor 
organization and the needs and requirements of the publicly supported 
organizations to constitute supervision or control in connection with 
such organizations.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. A, a philanthropist, founded X school for orphan boys (a 
publicly supported organization). At the same time A founded X school, 
he also established Y trust into which he transferred all of the 
operating assets of the school, together with a substantial endowment 
for it. Under the provisions of the trust instrument, the same persons 
who control and manage the school also control and manage the trust. The 
sole function of Y trust is to hold legal title to X school's operating 
and endowment assets, to invest the endowment assets and to apply the 
income from the endowment to the benefit of the school in accordance 
with direction from the school's governing body. Under these 
circumstances, Y trust is organized and operated for the benefit of X 
school and is supervised or controlled in connection with such 
organization within the meaning of section 509(a)(3). The fact that the 
same persons control both X and Y insures Y's responsiveness to X's 
needs.
    Example 2. In 1972, B, a philanthropist, created P, a charitable 
trust for the benefit of Z, a symphony orchestra described in section 
509(a)(2). B transferred 100 shares of common stock to P. Under the 
terms of the trust instrument, the trustees (none of whom is under the 
control of B) were required to pay over all of the income produced by 
the trust assets to Z. The governing instrument of P contains certain 
provisions whose effect is described in section 508(e)(1) (A) and (B). 
Under applicable State law, Z can enforce the provisions of the trust 
instrument and compel payment to Z in a court of equity. There is no 
relationship between the trustees of P and the governing body of Z. 
Under these circumstances P is not supervised or controlled in 
connection with a publicly supported organization. Because of the lack 
of any common supervision or control by the trustees of P and the 
governing body of Z, P is not supervised or controlled in connection 
with Z within the meaning of section 509(a)(3)(B).
    Example 3. T is a charitable trust described in section 501(c)(3) 
and created under the will of D. Prior to his death, D was a leader and 
very active in C church, a publicly supported organization. D created T 
to perpetuate his interest in, and assistance to, C. The sole purpose of 
T was to provide financial support for C and its related institutions. 
All of the original named trustees of T are members of C, are leaders in 
C, and hold important offices in one or more of C's related 
institutions. Successor trustees of T are by the terms of the charitable 
trust instrument to

[[Page 153]]

be chosen by the remaining trustees and are also to be members of C. All 
of the original trustees have represented that any successor trustee 
will be a leader in C and will hold an important office in one or more 
of C's related institutions. By reason of the foregoing relationship T 
and its trustees are responsive to the needs and requirements of C and 
its related institutions. Under these circumstances, T trust is 
organized and operated for the benefit of C and is supervised or 
controlled in connection with C and its related institutions within the 
meaning of section 509(a)(3)(B).

    (i) Meaning of operated in connection with--(1) General rule. (i) 
Except as provided in subdivisions (ii) and (iii) of this subparagraph 
and subparagraph (4) of this paragraph, a supporting organization will 
be considered as being operated in connection with one or more publicly 
supported organizations only if it meets the responsiveness test which 
is defined in subparagraph (2) of this paragraph and the integral part 
test which is defined in subparagraph (3) of this paragraph.
    (ii) In the case of an organization which was supporting or 
benefiting one or more publicly supported organizations before November 
20, 1970, additional facts and circumstances, such as a historic and 
continuing relationship between organizations, may be taken into 
account, in addition to the factors described in subparagraph (2) of 
this paragraph, to establish compliance with the responsiveness test.
    (iii) If:
    (a) A supporting organization can establish that it has met the 
integral part test set forth in subparagraph (3)(iii) of this paragraph 
for any 5-year period, and
    (b) Such organization cannot meet the requirements of such test for 
its current taxable year solely because the amount received by one or 
more of the publicly supported beneficiary organizations from such 
supporting organization is no longer sufficient, with respect to such 
beneficiary organizations, to satisfy subparagraph (3)(iii) of this 
paragraph, and
    (c) There has been a historic and continuing relationship of support 
between such organizations between the end of such 5-year period and the 
taxable year in question


then such supporting organization will be considered as meeting the 
requirements of the integral part test in subparagraph (3)(iii) of this 
paragraph for such taxable year.
    (2) Responsiveness test. (i) For purposes of this paragraph, a 
supporting organization will be considered to meet the responsiveness 
test if the organization is responsive to the needs or demands of the 
publicly supported organizations within the meaning of this 
subparagraph. In order to meet this test, either subdivision (ii) or 
subdivision (iii) of this subparagraph must be satisfied.
    (ii)(a) One or more officers, directors, or trustees of the 
supporting organization are elected or appointed by the officers, 
directors, trustees, or membership of the publicly supported 
organizations;
    (b) One or more members of the governing bodies of the publicly 
supported organizations are also officers, directors, or trustees of, or 
hold other important offices in, the supporting organization; or
    (c) The officers, directors, or trustees of the supporting 
organization maintain a close and continuous working relationship with 
the officers, directors, or trustees of the publicly supported 
organizations; and
    (d) By reason of (a), (b), or (c) of this subdivision, the officers, 
directors or trustees of the publicly supported organizations have a 
significant voice in the investment policies of the supporting 
organization, the timing of grants, the manner of making them, and the 
selection of recipients by such supporting organization, and in 
otherwise directing the use of the income or assets of such supporting 
organization.
    (iii)(a) The supporting organization is a charitable trust under 
State law;
    (b) Each specified publicly supported organization is a named 
beneficiary under such charitable trust's governing instrument; and
    (c) The beneficiary organization has the power to enforce the trust 
and compel an accounting under State law.
    (3) Integral part test; general rule. (i) For purposes of this 
paragraph, a supporting organization will be considered to meet the 
integral part test if it maintains a significant involvement in the

[[Page 154]]

operations of one or more publicly supported organizations and such 
publicly supported organizations are in turn dependent upon the 
supporting organization for the type of support which it provides. In 
order to meet this test, either subdivision (ii) or subdivision (iii) of 
this subparagraph must be satisfied.
    (ii) The activities engaged in for or on behalf of the publicly 
supported organizations are activities to perform the functions of, or 
to carry out the purposes of, such organizations, and, but for the 
involvement of the supporting organization, would normally be engaged in 
by the publicly supported organizations themselves.
    (iii) (a) The supporting organization makes payments of 
substantially all of its income to or for the use of one or more 
publicly supported organizations, and the amount of support received by 
one or more of such publicly supported organizations is sufficient to 
insure the attentiveness of such organizations to the operations of the 
supporting organization. In addition, a substantial amount of the total 
support of the supporting organization must go to those publicly 
supported organizations which meet the attentiveness requirement of this 
subdivision with respect to such supporting organization. Except as 
provided in (b) of this subdivision, the amount of support received by a 
publicly supported organization must represent a sufficient part of the 
organization's total support so as to insure such attentiveness. In 
applying the preceding sentence, if such supporting organization makes 
payments to, or for the use of, a particular department or school of a 
university, hospital or church, the total support of the department or 
school shall be substituted for the total support of the beneficiary 
organization.
    (b) Even where the amount of support received by a publicly 
supported beneficiary organization does not represent a sufficient part 
of the beneficiary organization's total support, the amount of support 
received from a supporting organization may be sufficient to meet the 
requirements of this subdivision if it can be demonstrated that in order 
to avoid the interruption of the carrying on of a particular function or 
activity, the beneficiary organization will be sufficiently attentive to 
the operations of the supporting organization. This may be the case 
where either the supporting organization or the beneficiary organization 
earmarks the support received from the supporting organization for a 
particular program or activity, even if such program or activity is not 
the beneficiary organization's primary program or activity so long as 
such program or activity is a substantial one.
    (c) This subdivision may be illustrated by the following examples:

    Example 1. X, an organization described in section 501(c)(3), pays 
over all of its annual net income to Y, a museum described in section 
509(a)(2). X meets the responsiveness test described in subparagraph (2) 
of this paragraph. In recent years, Y has earmarked the income received 
from X to underwrite the cost of carrying on a chamber music series 
consisting of 12 performances a year which are performed for the general 
public free of charge at its premises. Because of the expense involved 
in carrying on these recitals, Y is dependent upon the income from X for 
their continuation. Under these circumstances, X will be treated as 
providing Y with a sufficient portion of Y's total support to assure Y's 
attentiveness to X's operations, even though the chamber music series is 
not the primary part of Y's activities.
    Example 2. M, an organization described in section 501(c)(3), pays 
over all of its annual net income to the Law School of N University, a 
publicly supported organization. M meets the responsiveness test 
described in subparagraph (2) of this paragraph. M has earmarked the 
income paid over to N's Law School to endow a chair in its Department of 
International Law. Without M's continued support, N might not continue 
to maintain this chair. Under these circumstances, M will be treated as 
providing N with a sufficient portion of N's total support to assure N's 
attentiveness to M's operations.

    (d) All pertinent factors, including the number of beneficiaries, 
the length and nature of the relationship between the beneficiary and 
supporting organization and the purpose to which the funds are put (as 
illustrated by subdivision (iii) (b) and (c) of this subparagraph), will 
be considered in determining whether the amount of support

[[Page 155]]

received by a publicly supported beneficiary organization is sufficient 
to insure the attentiveness of such organization to the operations of 
the supporting organization. Normally the attentiveness of a beneficiary 
organization is motivated by reason of the amounts received from the 
supporting organization. Thus, the more substantial the amount involved, 
in terms of a percentage of the publicly supported organization's total 
support the greater the likelihood that the required degree of 
attentiveness will be present. However, in determining whether the 
amount received from the supporting organization is sufficient to insure 
the attentiveness of the beneficiary organization to the operations of 
the supporting organization (including attentiveness to the nature and 
yield of such supporting organization's investments), evidence of actual 
attentiveness by the beneficiary organization is of almost equal 
importance. An example of acceptable evidence of actual attentiveness is 
the imposition of a requirement that the supporting organization furnish 
reports at least annually for taxable years beginning after December 31, 
1971, to the beneficiary organization to assist such beneficiary 
organization in insuring that the supporting organization has invested 
its endowment in assets productive of a reasonable rate of return 
(taking appreciation into account) and has not engaged in any activity 
which would give rise to liability for a tax imposed under sections 
4941, 4943, 4944, or 4945 if such organization were a private 
foundation. The imposition of such requirement within 120 days after 
October 16, 1972, will be deemed to have retroactive effect to January 
1, 1970, for purposes of determining whether a supporting organization 
has met the requirements of this subdivision for its first two taxable 
years beginning after December 31, 1969. The imposition of such 
requirement is, however, merely one of the factors in determining 
whether a supporting organization is complying with this subdivision and 
the absence of such requirement will not preclude an organization from 
classification as a supporting organization based on other factors.
    (e) However, where none of the beneficiary organizations is 
dependent upon the supporting organization for a sufficient amount of 
the beneficiary organization's support within the meaning of this 
subdivision, the requirements of this subparagraph will not be 
satisfied, even though such beneficiary organizations have enforceable 
rights against such organization under State law.
    (4) Integral part test; transitional rule. (i) A trust (whether or 
not exempt from taxation under section 501(a)) which on November 20, 
1970, has met and continues to meet the requirements of subdivisions 
(ii) through (vi) of this subparagraph shall be treated as meeting the 
requirements of the integral part test (whether or not it meets the 
requirements of subparagraph (3) (ii) or (iii) of this paragraph) if for 
taxable years beginning after October 16, 1972, the trustee of such 
trust makes annual written reports to all of the beneficiary publicly 
supported organizations with respect to such trust setting forth a 
description of the assets of the trust, including a detailed list of the 
assets and the income produced by such assets. A trust organization 
which meets the requirements of this subparagraph may request a ruling 
that it is described in section 509(a)(3) in such manner as the 
Commissioner may prescribe.
    (ii) All the unexpired interests in the trust are devoted to one or 
more purposes described in section 170(c) (1) or (2)(B) and a deduction 
was allowed with respect to such interests under section 170, 545(b)(2), 
556(b)(2), 642(c), 2055, 2106(a)(2), 2522, or corresponding provisions 
of prior law (or would have been allowed such a deduction if the trust 
had not been created before 1913).
    (iii) The trust was created prior to November 20, 1970, and did not 
receive any grant, contribution, bequest or other transfer on or after 
such date. For purpose of this subdivision, a split-interest trust 
described in section 4947(a)(2) which was created prior to November 20, 
1970, which was irrevocable on such date, and which becomes a charitable 
trust described in section 4947(a)(1) after such date shall be treated 
as having been created prior to such date;
    (iv) The trust is required by its governing instrument to distribute 
all of

[[Page 156]]

its net income currently to a designated publicly supported beneficiary 
organization. Where more than one publicly supported beneficiary 
organization is designated in the governing instrument of a trust, all 
of the net income must be distributable and must be distributed 
currently to each of such beneficiary organizations in fixed shares 
pursuant to such governing instrument. For purposes of this subdivision, 
the governing instrument of a charitable trust shall be treated as 
requiring distribution to a designated beneficiary organization where 
the trust instrument describes the charitable purpose of the trust so 
completely that such description can apply to only one existing 
beneficiary organization and is of sufficient particularity as to vest 
in such organization rights against the trust enforceable in a court 
possessing equitable powers;
    (v) The trustee of the trust does not have discretion to vary either 
the beneficiaries or the amounts payable to the beneficiaries. For 
purposes of this subdivision, a trustee shall not be treated as having 
such discretion where the trustee has discretion to make payments of 
principal to the single section 509(a) (1) or (2) organization that is 
currently entitled to receive all of the trust's income or where the 
trust instrument provides that the trustee may cease making income 
payments to a particular charitable beneficiary in the event of certain 
specific occurrences, such as the loss of exemption under section 
501(c)(3) or classification under section 509(a) (1) or (2) by the 
beneficiary or the failure of the beneficiary to carry out its 
charitable purpose properly;
    (vi) None of the trustees would be disqualified persons within the 
meaning of section 4946(a) (other than foundation managers under 
4946(a)(1)(B)) with respect to the trust if such trust were treated as a 
private foundation.
    (5) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. N is a nonprofit publishing organization described in 
section 501(c)(3). It does all of the publishing and printing for the 
churches of a particular denomination (which are publicly supported 
organizations). Control of the organization is vested in a five-man 
Board of Directors, which includes one church official and four lay 
members of the congregations of that denomination. N does no other 
printing or publishing. It publishes all of the churches' religious as 
well as secular tracts and materials. Under these circumstances, N is 
considered as being operated in connection with a number of publicly 
supported organizations. Publishing religious literature is an integral 
part of the churches' activities; it is carried on by N on behalf of the 
churches, and there is sufficient direction of N's activities by the 
churches to insure responsiveness by N to their needs.
    Example 2. O, an alumni association described in section 501(c)(3), 
was formed to promote a spirit of loyalty among graduates of Y 
University, a publicly supported organization, and to effect united 
action in promoting the general welfare of the university. A special 
committee of Y's governing board meets with O and makes recommendations 
as to the allocation of O's program of gifts and scholarships to the 
university and its students. O also provides certain functions which 
would otherwise be part of Y's functions, such as maintaining records of 
alumni. O publishes a bulletin to keep alumni aware of the activities of 
the university. Under these circumstances O is considered to be operated 
in connection with Y within the meaning of section 509(a)(3)(B).
    Example 3. P is a trust created under the will of A for the purpose 
of furthering musical education. As a means of accomplishing its 
purposes P founded X, a school of music described in section 509(a)(1). 
The trust instrument is thereafter amended to name X specifically as the 
beneficiary of the trust. X can enforce its equitable rights as trust 
beneficiary under State law. Members of the governing body of X form a 
minority of the foundation managers of P. For many years the 
organizations have been operated in close association with each other. P 
provides the principal endowment fund for the operation of X. In 
addition, while the governing body of X concerns itself with artistic 
policies, the foundation managers of P handle the budgetary concerns of 
X. X's annual budget is prepared with the assistance of P's foundation 
managers and is approved by P. Under these circumstances, P is 
considered to be operated in connection with X within the meaning of 
section 509(a)(3)(B).
    Example 4. Q is a charitable trust described in section 501(c)(3) 
and created under the will of C. Prior to his death, C built H Hospital 
and deeded it to I University for use as a training and clinical 
facility for I's medical school. Both H and I are publicly supported 
organizations. C created Q to perpetuate his interest in, and assistance 
to, H Hospital. The sole purpose of Q was to provide financial support 
for H, the beneficiary organization named in C's will. H can enforce its 
equitable rights as trust beneficiary under

[[Page 157]]

State law. After the death of C, Q continued to provide substantial 
support for H. It was primarily responsible for the erecting of a new 
hospital building, as well as the construction of other facilities for 
the hospital. In addition, each medical department of H indicates during 
the year what its greatest needs are. Once these requests are approved 
by the medical director of I University's Medical School, they are 
presented to Q, and subject to the amount of Q's income (all of which is 
applied to H), these requests are honored and the new equipment of 
facility is supplied through Q's funds. The governing body of Q and 
those of H and I are completely independent. However, based on the above 
facts, Q is responsive to the needs of H, Q maintains a substantial 
involvement in the conduct of H, and H is substantially dependent upon 
the receipt of support from Q. Accordingly, Q is operated in connection 
with one or more section 509(a)(1) organizations within the meaning of 
section 509(a)(3)B).
    Example 5. R is a charitable trust created under the will of B, who 
died in 1971. Its purpose is to hold assets as an endowment for S, a 
hospital, T, a university, and U, a national medical research 
organization (all being publicly supported organizations and 
specifically named in the trust instrument), and to distribute all of 
the income each year in equal shares among the three named 
beneficiaries. S, T, and U have certain enforceable rights against R 
under State law, including the right to compel an accounting. Except for 
making these annual payments, the trustees of R have no further contacts 
or relationships with S, T, or U. The payments by R to such 
organizations do not comprise a sufficient amount of support to meet the 
requirements of subparagraph (3) of this paragraph for any of these 
organizations. Although R meets the responsiveness test described in 
subparagraph (2) of this paragraph, it does not meet the integral part 
test described in subparagraph (3) of this paragraph. R is not, 
therefore, considered as operated in connection with one or more 
publicly supported organizations within the meaning of section 
509(a)(3)B). However, if B had died prior to November 20, 1970, R could, 
upon meeting all of the requirements of subparagraph (4) of this 
paragraph, be considered as operated in connection with one or more of 
publicly supported organizations within the meaning of section 
509(a)(3)(B).
    Example 6. S is a charitable trust described in section 501(c)(3). S 
was created under the will of C in 1910 for the purpose of providing 
aged and indigent women with care and shelter. Prior to his death in 
1910, C helped to create T, a home for aged women, through a substantial 
inter vivos contribution. Although T is not specifically named in C's 
will, the trustees of S (who are completely independent of T) have paid 
over all of S's income to T in furtherance of the trust's purposes since 
the death of C. S establishes that between 1910 and 1955, the amount of 
support received by T from S was sufficient support to satisfy the 
provisions of Sec. 1.509(a)-4(i)(3)(iii). In 1956, T merged with U, a 
home for aged and indigent men, and V, a nursing home. S continued to 
pay all its income to W, the organization resulting from the merger of 
T, U, and V. However, as a result of the merger and certain changes in 
the methods of financing the operations, the payments made by S after 
1955 no longer were sufficient to satisfy the integral part test of 
Sec. 1.509(a)-4(i)(3)(iii). W qualifies as an organization described in 
section 509(a)(2). For the taxable year 1971, S meets the responsiveness 
test under Sec. 1.509(a)-4(i)(2)(ii). Although W is not a named 
beneficiary under S's governing instrument, pursuant to Sec. 1.509(a)-
4(i)(1)(ii) the historic and continuing relationship between the 
organizations will be taken into account to establish compliance with 
the responsiveness test. Furthermore, pursuant to Sec. 1.509(a)-
4(i)(1)(iii), under the facts set forth above, the integral part test 
under Sec. 1.509(a)-4(i)(3)(iii) will be considered as being satisfied 
for the taxable year 1971. Thus S will be considered as operated in 
connection with W for the taxable year 1971.

    (j) Control by disqualified persons--(1) In general. Under the 
provisions of section 509(a)(3)(C) a supporting organization may not be 
controlled directly or indirectly by one or more disqualified persons 
(as defined in section 4946) other than foundation managers and other 
than one or more publicly supported organizations. If a person who is a 
disqualified person with respect to a supporting organization, such as a 
substantial contributor to the supporting organization, is appointed or 
designated as a foundation manager of the supporting organization by a 
publicly supported beneficiary organization to serve as the 
representative of such publicly supported organization, then for 
purposes of this paragraph such person will be regarded as a 
disqualified person, rather than as a representative of the publicly 
supported organization. An organization will be considered controlled, 
for purposes of section 509(a)(3)(C), if the disqualified persons, by 
aggregating their votes or positions of authority, may require such 
organization to perform any act which significantly affects its 
operation or may prevent such organization from performing such act. 
This includes, but is

[[Page 158]]

not limited to, the right of any substantial contributor or his spouse 
to designate annually the recipients, from among the publicly supported 
organizations of the income attributable to his contribution to the 
supporting organization. Except as provided in subparagraph (2) of this 
paragraph, a supporting organization will be considered to be controlled 
directly or indirectly by one or more disqualified persons if the voting 
power of such persons is 50 percent or more of the total voting power of 
the organization's governing body or if one or more of such persons have 
the right to exercise veto power over the actions of the organization. 
Thus, if the governing body of a foundation is composed of five 
trustees, none of whom has a veto power over the actions of the 
foundation, and no more than two trustees are at any time disqualified 
persons, such foundation will not be considered to be controlled 
directly or indirectly by one or more disqualified persons by reason of 
this fact alone. However, all pertinent facts and circumstances 
including the nature, diversity, and income yield of an organization's 
holdings, the length of time particular stocks, securities, or other 
assets are retained, and its manner of exercising its voting rights with 
respect to stocks in which members of its governing body also have some 
interest, will be taken into consideration in determining whether a 
disqualified person does in fact indirectly control an organization.
    (2) Proof of independent control. Notwithstanding subparagraph (1) 
of this paragraph, an organization shall be permitted to establish to 
the satisfaction of the Commissioner that disqualified persons do not 
directly or indirectly control it. For example, in the case of a 
religious organization operated in connection with a church, the fact 
that the majority of the organization's governing body is composed of 
lay persons who are substantial contributors to the organization will 
not disqualify the organization under section 509(a)(3)(C) if a 
representative of the church, such as a bishop or other official, has 
control over the policies and decisions of the organization.
    (k) Organizations operated in conjunction with certain section 
501(c) (4), (5), or (6) organizations. (1) For purposes of section 
509(a)(3), an organization which is operated in conjunction with an 
organization described in section 501(c) (4), (5), or (6) (such as a 
social welfare organization, labor or agricultural organization, 
business league, or real estate board) shall, if it otherwise meets the 
requirements of section 509(a)(3), be considered an organization 
described in section 509(a)(3) if such section 501(c) (4), (5), or (6) 
organization would be described in section 509(a)(2) if it were an 
organization described in section 501(c)(3). The section 501(c) (4), 
(5), or (6) organization, which the supporting organization is operating 
in conjunction with, must therefore meet the one-third tests of a 
publicly supported organization set forth in section 509(a)(2).
    (2) This paragraph may be illustrated by the following example:

    Example. X medical association, described in section 501(c)(6), is 
supported by membership dues and funds resulting from the performance of 
its exempt activities. This support, which is entirely from permitted 
sources, constitutes more than one-third of X's support. X does not 
normally receive more than one-third of its support from items described 
in section 509(a)(2)(B). X organized and operated an endowment fund for 
the sole purpose of furthering medical education. The fund is an 
organization described in section 501(c)(3). Since more than one-third 
of X's support is derived from membership dues and from funds resulting 
from the performance of exempt purposes (all of which are from permitted 
sources) and not more than one-third of its support is from items 
described in section 509(a)(2)(B), it would be a publicly supported 
organization described in section 509(a)(2) if it were described in 
section 501(c)(3) rather than section 501(c)(6). Accordingly, if the 
fund otherwise meets the requirements of section 509(a)(3) with respect 
to X, it will be considered an organization described in section 
509(a)(3).

[T.D. 7212, 37 FR 21916, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 
37890, July 23, 1981]



Sec. 1.509(a)-5  Special rules of attribution.

    (a) Retained character of gross investment income. (1) For purposes 
of determining whether an organization meets the not-more-than-one-third 
support test set forth in section 509(a)(2)(B),

[[Page 159]]

amounts received by such organization from:
    (i) An organization which seeks to be described in section 509(a)(3) 
by reason of its support of such organization; or
    (ii) A charitable trust, corporation, fund, or association described 
in section 501(c)(3) (including a charitable trust described in section 
4947(a)(1)) or a split interest trust described in section 4947(a)(2), 
which is required by its governing instrument or otherwise to 
distribute, or which normally does distribute, at least 25 percent of 
its adjusted net income (within the meaning of section 4942(f)) to such 
organization, and such distribution normally comprises at least 5 
percent of such distributee organization's adjusted net income


will retain their character as gross investment income (rather than 
gifts or contributions) to the extent that such amounts are 
characterized as gross investment income in the possession of the 
distributing organization described in subdivision (i) or (ii) of this 
subparagraph or, if the distributing organization is a split interest 
trust described in section 4947(a)(2), to the extent that such amounts 
would be characterized as gross investment income attributable to 
transfers in trust after May 26, 1969, if such trust were a private 
foundation. For purposes of this section, all income which is 
characterized as gross investment income in the possession of the 
distributing organization shall be deemed to be distributed first by 
such organization and shall retain its character as such in the 
possession of the recipient of amounts described in this paragraph. If 
an organization described in subdivision (i) or (ii) of this 
subparagraph makes distributions to more than one organization, the 
amount of gross investment income deemed distributed shall be prorated 
among the distributees.
    (2) For purposes of subparagraph (1) of this paragraph, amounts paid 
by an organization to provide goods, services, or facilities for the 
direct benefit of an organization seeking section 509(a)(2) status 
(rather than for the direct benefit of the general public) shall be 
treated in the same manner as amounts received by the latter 
organization. Such amounts will be treated as gross investment income to 
the extent that such amounts are characterized as gross investment 
income in the possession of the organization spending such amounts. For 
example, X is an organization described in subparagraph (1)(i) of this 
paragraph. It uses part of its funds to provide Y, an organization 
seeking section 509(a)(2) status, with certain services which Y would 
otherwise be required to purchase on its own. To the extent that the 
funds used by X to provide such services for Y are characterized as 
gross investment income in the possession of X, such funds will be 
treated as gross investment income received by Y.
    (3) An organization seeking section 509(a)(2) status shall file a 
separate statement with its return required by section 6033, setting 
forth all amounts received from organizations described in paragraph 
(a)(1) (i) or (ii) of this section.
    (b) Relationships created for avoidance purposes. (1) If a 
relationship between an organization seeking section 509(a)(3) status 
and an organization seeking section 509(a)(2) status:
    (i) Is established or availed of after October 9, 1969, and
    (ii) One of the purposes of establishing or utilizing such 
relationship is to avoid classification as a private foundation with 
respect to either organization, the character and amount of support 
received by the section 509(a)(3) organization will be attributed to the 
section 509(a)(2) organization for purposes of determining whether the 
latter meets the one-third support test and the not-more-than-one-third 
support test under section 509(a)(2). If a relationship described in 
this subparagraph is established or utilized by an organization seeking 
section 509(a)(3) status and two or more organizations seeking section 
509(a)(2) status, the amount of support received by the former 
organization will be prorated among the latter organizations and the 
character of each class of support (as defined in section 509(d)) will 
be attributed pro rata to each such organization. The provisions of this 
paragraph and of paragraph (a) of this section are not mutually 
exclusive.

[[Page 160]]

    (2) In determining whether a relationship between one or more 
organizations seeking section 509(a)(2) status (hereinafter referred to 
as beneficiary organizations) and an organization seeking section 
509(a)(3) status (hereinafter referred to as the supporting 
organization) has been established or availed of to avoid classification 
as a private foundation (within the meaning of subparagraph (1) of this 
paragraph), all pertinent facts and circumstances, including the 
following, shall be taken into account as evidence that a relationship 
was not established or availed of to avoid classification as a private 
foundation:
    (i) The supporting organization is operated to support or benefit 
several specified beneficiary organizations.
    (ii) The beneficiary organization has a substantial number of dues-
paying members (in relation to the public it serves and the nature of 
its activities) and such members have an effective voice in the 
management of both the supporting and beneficiary organizations.
    (iii) The beneficiary organization is composed of several membership 
organizations, each of which has a substantial number of members (in 
relation to the public it serves and the nature of its activities), and 
such membership organizations have an effective voice in the management 
of the supporting and beneficiary organizations.
    (iv) The beneficiary organization receives a substantial amount of 
support from the general public, public charities, or governmental 
grants.
    (v) The supporting organization uses its funds to carry on a 
meaningful program of activities to support or benefit the beneficiary 
organization and such use would, if such supporting organization were a 
private foundation, be sufficient to avoid the imposition of any tax 
upon such organization under section 4942.
    vi) The supporting organization is not able to exercise substantial 
control or influence over the beneficiary organization by reason of the 
former's receiving support or holding assets which are 
disproportionately large in comparison with the support received or the 
assets held by the latter.
    (vii) Different persons manage the operations of the beneficiary and 
supporting organizations and each organization performs a different 
function.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. M, an organization described in section 509(a)(2), is a 
council composed of 10 learned societies. Each member society has a 
large membership of scholars interested in a particular academic area. 
In 1970 M established N, an organization seeking section 509(a)(3) 
status, for the purpose of carrying on research and study projects of 
interest to the member societies. The principal source of funds for N's 
activities is from foundation and government grants and contracts. The 
principal source of funds for M's activities after the creation of N is 
membership dues. M continued to maintain a wide variety of activities 
for its members, such as publishing periodicals and carrying on seminars 
and conferences. N is subject to complete control by the governing body 
of M. Under these circumstances, the relationship between these 
organizations is not one which is described in subparagraph (1) of this 
paragraph.
    Example 2. Q is a local medical research organization described in 
section 509(a)(2). Its fixed assets are negligible and it carries on 
research activities on a limited scale. It also makes a limited number 
of grants to scientists and doctors who are engaged in medical research 
of interest to Q. It receives support through small government grants 
and a few research contracts from private foundations. R is an 
organization described in section 501(c)(3). As of January 1, 1970, R 
was classified as a private foundation under section 509. It has a 
substantial endowment which it uses to make grants to various charitable 
and scientific organizations described in section 501(c)(3). During 
1970, R agrees to subsidize the research activities of Q. R amends its 
governing instrument to provide specifically that all of R's support 
will be used for research activities which are approved and supervised 
by Q. R also amends its bylaws to permit a minority of Q's board of 
directors to be members of R's governing body. R then gives timely 
notification under section 507(b)(1)(B)(ii) that R is terminating its 
private foundation status by meeting the requirements of section 
509(a)(3) by the end of the 12-month period described in section 
507(b)(1)(B)(i). For purposes of determining whether R has met the 
requirements of section 509(a)(3) by the end of the 12-month period, as 
well as determining Q's status under section 509(a)(2), the character 
and amount of support received by R will be attributed to Q.


[[Page 161]]


    (c) Effect on organizations claiming section 509(a)(3) status. If an 
organization claiming section 509(a)(2) status fails to meet either the 
one-third support test or the not-more-than-one-third support test under 
section 509(a)(2) by reason of the application of the provisions of 
paragraph (a) or (b) of this section, and such organization is one of 
the specified organizations (within the meaning of section 509(a)(3)(A)) 
for whose support or benefit an organization claiming section 509(a)(3) 
status is operated, the organization claiming section 509(a)(3) status 
will not be considered to be operated exclusively to support or benefit 
one or more section 509(a) (1) or (2) organizations.

[T.D. 7212, 37 FR 21922, Oct. 17, 1972, as amended by T.D. 7290, 38 FR 
31834, Nov. 19, 1973; T.D. 7784, 46 FR 37890, July 23, 1981]



Sec. 1.509(a)-6  Classification under section 509(a).

    If an organization is described in section 509(a)(1) and also in 
another paragraph of section 509(a), it will be treated as described in 
section 509(a)(1). For purposes of this section, the parenthetical 
language other than in clauses (vii) and (viii) used in section 
509(a)(1) shall be construed to mean other than an organization which is 
described only in clause (vii) or (viii). For example, X is an 
organization which is described in section 170(b)(1)(A)(vi), but could 
also meet the description of section 170(b)(1)(A)(viii) as an 
organization described in section 509(a)(2). For purposes of the one-
third support test in section 509(a)(2)(A), contributions from X to 
other organizations will be treated as support from an organization 
described in section 170(b)(1)(A)(vi) rather than from an organization 
described in section 170(b)(1)(A)(viii).

[T.D. 7212, 37 FR 21923, Oct. 17, 1972]



Sec. 1.509(a)-7  Reliance by grantors and contributors to section 509(a) (1), 

(2), and (3) organizations.

    (a) General rule. Once an organization has received a final ruling 
or determination letter classifying it as an organization described in 
section 509(a) (1), (2), or (3), the treatment of grants and 
contributions and the status of grantors and contributors to such 
organization under sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 
4942, 4945, 2055, 2106(a)(2), and 2522 will not be affected by reason of 
a subsequent revocation by the service of the organization's 
classification as described in section 509(a) (1), (2), or (3) until the 
date on which notice of change of status is made to the public (such as 
by publication in the Internal Revenue Bulletin) or another applicable 
date, if any, specified in such public notice. In appropriate cases, 
however, the treatment of grants and contributions and the status of 
grantors and contributors to an organization described in section 509(a) 
(1), (2), or (3) may be affected pending verification of the continued 
classification of such organization under section 509(a) (1), (2), or 
(3). Notice to this affect will be made in a public announcement by the 
service. In such cases the effect of grants and contributions made after 
the date of the announcement will depend upon the statutory 
qualification of the organization as an organization described in 
section 509(a) (1), (2), or (3).
    (b) Exceptions. (1) Paragraph (a) of this section shall not apply if 
the grantor or contributor:
    (i) Had knowledge of the revocation of the ruling or determination 
letter classifying the organization as an organization described in 
section 509(a) (1), (2), or (3), or
    (ii) Was in part responsible for, or was aware of, the act, the 
failure to act, or the substantial and material change on the part of 
the organization which gave rise to the revocation of the ruling or 
determination letter classifying the organization as an organization 
described in section 509(a) (1), (2), or (3).
    (2) Paragraph (a) of this section shall not apply where a different 
rule is otherwise expressly provided in the regulations under sections 
170(b)(1)(A), 507(b)(1)(B), or 509.

[T.D. 7212, 37 FR 21923, Oct. 17, 1972]



Sec. 1.509(b)-1  Continuation of private foundation status.

    (a) In general. If an organization is a private foundation (within 
the meaning of section 509(a)) on October 9, 1969, or becomes a private 
foundation on any subsequent date, such organization shall be treated as 
a private foundation

[[Page 162]]

for all periods after October 9, 1969, or after such subsequent date, 
unless its status as such is terminated under section 507. Therefore, if 
an organization was described in section 501(c)(3) and was a private 
foundation within the meaning of section 509(a) on October 9, 1969, it 
shall be treated as a private foundation for all periods thereafter, 
even though it may also satisfy the requirements of an organization 
described in some other paragraph of section 501(c). For example, if on 
October 9, 1969, an organization was described in section 501(c)(3), but 
because of its activities, it could also have qualified as an 
organization described in section 501(c)(4), such organization will 
continue to be treated as a private foundation, if it was a private 
foundation within the meaning of section 509(a) on October 9, 1969.
    (b) Taxable private foundations. If an organization is a private 
foundation on October 9, 1969, and it is determined that it is not 
exempt under section 501(a) as an organization described in section 
501(c)(3) as of any date after October 9, 1969, such organization, even 
though it may operate thereafter as a taxable entity, will continue to 
be treated as a private foundation unless its status as such is 
terminated under section 507. For example, X organization is a private 
foundation on October 9, 1969. It is subsequently determined that, as of 
July 1, 1972, X is no longer exempt under section 501(a) as an 
organization described in section 501(c)(3) because, for example, it has 
not conformed its governing instrument pursuant to section 508(e). X 
will continue to be treated as a private foundation after July 1, 1972, 
unless its status as such is terminated under section 507. However, if 
an organization is not exempt under section 501(a) as an organization 
described in section 501(c)(3) on October 9, 1969, then it will not be 
treated as a private foundation within the meaning of section 509(a) by 
reason of section 509(b), unless it becomes a private foundation on a 
subsequent date.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]



Sec. 1.509(c)-1  Status of organization after termination of private 

foundation status.

    (a) In general. For purposes of part II of subchapter F of this 
chapter, an organization whose status as a private foundation is 
terminated under section 507 shall be treated as an organization created 
on the day after the date of such termination. An organization whose 
private foundation status has been terminated under the provisions of 
section 507(a) will, if it continues to operate, be treated as a new 
organization and must, if it desires to be classified under section 
501(c)(3), give notification that it is applying for recognition of 
section 501(c)(3) status pursuant to the provisions of section 508(a).
    (b) Effect upon section 507(d)(1). If the private foundation status 
of an organization has been terminated under section 507(b)(1)(B) and 
the regulations thereunder, and:
    (1) Such organization does not continue at all times thereafter to 
meet the requirements of section 509(a) (1), (2), or (3) (and is 
therefore no longer excluded from the definition of a private 
foundation); and
    (2) The status of such organization as a private foundation is 
thereafter terminated under section 507(a)


then the tax imposed under section 507(c)(1) upon the aggregate tax 
benefit (described in section 507(d)(1)) resulting from section 
501(c)(3) status shall be computed only upon the aggregate tax benefit 
resulting after the date on which the organization again becomes a 
private foundation under subparagraph (1) of this paragraph.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]



Sec. 1.509(d)-1  Definition of support

    For purposes of section 509(a)(2), the term support does not include 
amounts received in repayment of the principal of a loan or other 
indebtedness. See, however, section 509(e) as to amounts received as 
interest on a loan or other indebtedness.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]

[[Page 163]]



Sec. 1.509(e)-1  Definition of gross investment income.

    For the distinction between gross receipts and gross investment 
income, see Sec. 1.509(a)-3(m).

(Sec. 7805, Internal Revenue Code of 1954, 68A Stat. 917; 26 U.S.C. 
7805)

[T.D. 7212, 37 FR 21925, Oct. 17, 1972]

       Taxation of Business Income of Certain Exempt Organizations



Sec. 1.511-1  Imposition and rates of tax.

    Section 511(a) imposes a tax upon the unrelated business taxable 
income of certain organizations otherwise exempt from Federal income 
tax. Under section 511(a)(1), organizations described in section 
511(a)(2)(A) and in paragraph (a) of Sec. 1.511-2 and organizations 
described in section 511(a)(2)(B) are subject to normal tax and surtax 
at the corporate rates provided by section 11. Under section 511(b)(1), 
trusts described in section 511(b)(2) are subject to tax at the 
individual rates prescribed in section 1(d) of the Code as amended by 
the Tax Reform Act of 1969 (section 1 for taxable years ending before 
Jan. 1, 1971). The deduction for personal exemption provided in section 
642(b) in the case of a trust taxable under subchapter J, chapter 1 of 
the Code, is not allowed in computing unrelated business taxable income.

[T.D. 7117, 36 FR 9421, May 25, 1971]



Sec. 1.511-2  Organizations subject to tax.

    (a) Organizations other than trusts and title holding companies. 
(1)(i) The taxes imposed by section 511(a)(1) apply in the case of any 
organization (other than a trust described in section 511(b)(2) or an 
organization described in section 501(c)(1)) which is exempt from 
taxation under section 501(a) (except as provided in sections 507 
through 515). For special rules concerning corporations described in 
section 501(c)(2), see paragraph (c) of this section.
    (ii) In the case of an organization described in section 501(c)(4), 
(7), (8), (9), (10), (11), (12), (13), (14)(A), (15), (16), or (18), the 
taxes imposed by section 511(a)(1) apply only for taxable years 
beginning after December 31, 1969. In the case of an organization 
described in section 501(c)(14) (B) or (C), the taxes imposed by section 
511(a)(1) apply only for taxable years beginning after February 2, 1966.
    (2) The taxes imposed by section 511(a) apply in the case of any 
college or university which is an agency or instrumentality of any 
government or any political subdivision thereof, or which is owned or 
operated by a government or any political subdivision thereof or by any 
agency or instrumentality of any one or more governments or political 
subdivisions. Such taxes also apply in the case of any corporation 
wholly owned by one or more such colleges or universities. As here used, 
the word government includes any foreign government (to the extent not 
contrary to any treaty obligation of the United States) and all domestic 
governments (the United States and any of its Territories or 
possessions, any State, and the District of Columbia). Elementary and 
secondary schools operated by such governments are not subject to the 
tax on unrelated business income.
    (3)(i) For taxable years beginning before January 1, 1970, churches 
and associations or conventions of churches are exempt from the taxes 
imposed by section 511. The exemption is applicable only to an 
organization which itself is a church or an association or convention of 
churches. Subject to the provisions of subdivision (ii) of this 
subparagraph, religious organizations, including religious orders, if 
not themselves churches or associations or conventions of churches, and 
all other organizations which are organized or operated under church 
auspices, are subject to the tax imposed by section 511, whether or not 
they engage in religious, educational, or charitable activities approved 
by a church.
    (ii) The term church includes a religious order or a religious 
organization if such order or organization (a) is an integral part of a 
church, and (b) is engaged in carrying out the functions of a church, 
whether as a civil law corporation or otherwise. In determining whether 
a religious order or organization is an integral part of a church, 
consideration will be given to the degree to which it is connected with, 
and controlled by, such church. A religious

[[Page 164]]

order or organization shall be considered to be engaged in carrying out 
the functions of a church if its duties include the ministration of 
sacerdotal functions and the conduct of religious worship. If a 
religious order or organization is not an integral part of a church, or 
if such an order or organization is not authorized to carry out the 
functions of a church (ministration of sacerdotal functions and conduct 
of religious worship) then it is subject to the tax imposed by section 
511 whether or not it engages in religious, educational, or charitable 
activities approved by a church. What constitutes the conduct of 
religious worship or the ministration of sacerdotal functions depends on 
the tenets and practices of a particular religious body constituting a 
church. If a religious order or organization can fully meet the 
requirements stated in this subdivision, exemption from the tax imposed 
by section 511 will apply to all its activities, including those which 
it conducts through a separate corporation (other than a corporation 
described in section 501(c)(2)) or other separate entity which it wholly 
owns and which is not operated for the primary purpose of carrying on a 
trade or business for profit. Such exemption from tax will also apply to 
activities conducted through a separate corporation (other than a 
corporation described in section 501(c)(2)) or other separate entity 
which is wholly owned by more than one religious order or organization, 
if all such orders or organizations fully meet the requirements stated 
in this subdivision and if such corporation or other entity is not 
operated for the primary purpose of carrying on a trade or business for 
profit.
    (iii) For taxable years beginning after December 31, 1969, churches 
and conventions or associations of churches are subject to the taxes 
imposed by section 511, unless otherwise entitled to the benefit of the 
transitional rules of section 512(b)(14) and Sec. 1.512(b)-1(i).
    (b) Trusts--(1) In general. The taxes imposed by section 511(b) 
apply in the case of any trust which is exempt from taxation under 
section 501(a) (except as provided in sections 507 through 515), and 
which, if it were not for such exemption, would be subject to the 
provisions of subchapter J, chapter 1, of the Code. An organization 
which is considered as trustee of a stock bonus, pension, or profit-
sharing plan described in section 401(a), a supplemental unemployment 
benefit trust described in section 501(c)(17), or a pension plan 
described in section 501(c)(18) (regardless of the form of such 
organization) is subject to the taxes imposed by section 511(b)(1) on 
its unrelated business income. However, if such an organization conducts 
a business which is a separate taxable entity on the basis of all the 
facts and circumstances, for example, an association taxable as a 
corporation, the business will be taxable as a feeder organization 
described in section 502.
    (2) Effective dates. In the case of a trust described in section 
501(c)(3), the taxes imposed by section 511(b) apply for taxable years 
beginning after December 31, 1953. In the case of a trust described in 
section 401(a), the taxes imposed by section 511(b) apply for taxable 
years beginning after June 30, 1954. In the case of a trust described in 
section 501(c)(17), the taxes imposed by section 511(b) apply for 
taxable years beginning after December 31, 1959. In the case of any 
other trust described in subparagraph (1) of this paragraph, the taxes 
imposed by section 511(b) apply for taxable years beginning after 
December 31, 1969.
    (c) Title Holding Companies--(1) In general. If a corporation 
described in section 501(c)(2) pays any amount of its net income for a 
taxable year to an organization exempt from taxation under section 
501(a) (or would pay such an amount but for the fact that the expenses 
of collecting its income exceed its income), and if such corporation and 
such organization file a consolidated income tax return for such taxable 
year, then such corporation shall be treated, for purposes of the tax 
imposed by section 511(a), as being organized and operated for the same 
purposes as such organization, as well as for its title-holding purpose. 
Therefore, if an item of income of the section 501(c)(2) corporation is 
derived from a source which is related to the exempt function of the 
exempt organization to which such income is payable and with

[[Page 165]]

which such corporation files a consolidated return, such item is, 
together with all deductions directly connected therewith, excluded from 
the determination of unrelated business taxable income under section 512 
and shall not be subject to the tax imposed by section 511(a). If, 
however, such item of income is derived from a source which is not so 
related, then such item, less all deductions directly connected 
therewith, is, subject to the modifications provided in section 512(b), 
unrelated business taxable income subject to the tax imposed by section 
511(a).
    (2) The provisions of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. The income of X, a section 501(c)(2) corporation, is 
required to be distributed to exempt organization A. During the taxable 
year X realizes net income of $900,000 from source M and $100,000 from 
source N. Source M is related to A's exempt function, while source N is 
not so related. X and A file a consolidated return for such taxable 
year. X has net unrelated business income of $100,000, subject to the 
modifications in section 512(b).

    (3) Cross reference. For rules relating generally to the filing of 
consolidated returns by certain organizations exempt from taxation under 
section 501(a), see section 1504(e) of the Code and Sec. 1.1502-100.
    (4) Effective dates. Subparagraphs (1) through (3) of this paragraph 
apply with respect to taxable years beginning after December 31, 1969. 
For taxable years beginning before January 1, 1970, a corporation 
described in section 501(c)(2) and otherwise exempt from taxation under 
section 501(a) is taxable upon its unrelated business taxable income 
only if such income is payable either:
    (i) To a church or convention or association of churches, or
    (ii) To any organization subject, for taxable years beginning before 
January 1, 1970, to the tax imposed by section 511(a)(1).
    (d) The fact that any class of organizations exempt from taxation 
under section 501(a) is subject to the unrelated business income tax 
under section 511 and this section does not in any way enlarge the 
permissible scope of business activities of such class for purposes of 
the continued qualification of such class under section 501(a).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7183, 37 FR 
7884, Apr. 21, 1972; T.D. 7632, 44 FR 42681, July 20, 1979]



Sec. 1.511-3  Provisions generally applicable to the tax on unrelated business 

income.

    (a) Assessment and collections. Since the taxes imposed by section 
511 are taxes imposed by subtitle A of the Code, all provisions of law 
and of the regulations applicable to the taxes imposed by subtitle A are 
applicable to the assessment and collection of the taxes imposed by 
section 511. Organizations subject to the tax imposed by section 
511(a)(1) are subject to the same provisions, including penalties, as 
are provided in the case of the income tax of other corporations. In the 
case of a trust subject to the tax imposed by section 511(b)(1), the 
fiduciaries for such trust are subject to the same provisions, including 
penalties, as are applicable to fiduciaries in the case of the income 
tax of other trusts. See section 6151, et seq., and the regulations 
prescribed thereunder, for provisions relating to payment of tax.
    (b) Returns. For requirements of filing annual returns with respect 
to unrelated business taxable income by organizations subject to the tax 
on such income, see section 6012, paragraph (e) of Sec. 1.6012-2, and 
paragraph (a)(5) of Sec. 1.6012-3.
    (c) Taxable years, method of accounting, etc. The taxable year 
(fiscal year or calendar year, as the case may be) of an organization 
shall be determined without regard to the fact that such organization 
may have been exempt from tax during any prior period. See sections 441 
and 446, and the regulations thereunder in this part, and section 7701 
and the regulations in part 301 of this chapter (Regulations on 
Procedure and Administration). Similarly, in computing unrelated 
business taxable income, the determination of the taxable year for which 
an item of income or expense is taken into account shall be made under 
the provisions of sections 441, 446, 451, and 461, and the regulations 
thereunder, whether or not the item arose during a taxable year 
beginning before, on, or after the effective

[[Page 166]]

date of the provisions imposing a tax upon unrelated business taxable 
income. If a method for treating bad debts was selected in a return of 
income (other than an information return) for a previous taxable year, 
the taxpayer must follow such method in its returns under section 511, 
unless such method is changed in accordance with the provisions of Sec. 
1.166-1. A taxpayer which has not previously selected a method for 
treating bad debts may, in its first return under section 511, exercise 
the option granted in Sec. 1.166-1.
    (d) Foreign tax credit. See section 515 for provisions applicable to 
the credit for foreign taxes provided in section 901.



Sec. 1.511-4  Minimum tax for tax preferences.

    The tax imposed by section 56 applies to an organization subject to 
tax under section 511 with respect to items of tax preference which 
enter into the computation of unrelated business taxable income. For 
this purpose, only those items of income and those deductions entering 
into the determination of the tax imposed by this section are considered 
in the determination of the items of tax preference under section 57. 
For rules relating to the minimum tax for tax preferences, see sections 
56 through 58 and the regulations thereunder.

[T.D. 7564, 43 FR 40494, Sept. 12, 1978]



Sec. 1.512(a)-1  Definition.

    (a) In general. Except as otherwise provided in Sec. 1.512(a)-3, 
Sec. 1.512(a)-4, or paragraph (f) of this section, section 512(a)(1) 
defines unrelated business taxable income as the gross income derived 
from any unrelated trade or business regularly carried on, less those 
deductions allowed by chapter 1 of the Code which are directly connected 
with the carrying on of such trade or business, subject to certain 
modifications referred to in Sec. 1.512(b)-1. To be deductible in 
computing unrelated business taxable income, therefore, expenses, 
depreciation, and similar items not only must qualify as deductions 
allowed by chapter 1 of the Code, but also must be directly connected 
with the carrying on of unrelated trade or business. Except as provided 
in paragraph (d)(2) of this section, to be directly connected with the 
conduct of unrelated business for purposes of section 512, an item of 
deduction must have proximate and primary relationship to the carrying 
on of that business. In the case of an organization which derives gross 
income from the regular conduct of two or more unrelated business 
activities, unrelated business taxable income is the aggregate of gross 
income from all such unrelated business activities less the aggregate of 
the deductions allowed with respect to all such unrelated business 
activities. For the treatment of amounts of income or loss of common 
trust funds, see Sec. 1.584-2(c)(3).
    (b) Expenses attributable solely to unrelated business activities. 
Expenses, depreciation, and similar items attributable solely to the 
conduct of unrelated business activities are proximately and primarily 
related to that business activity, and therefore qualify for deduction 
to the extent that they meet the requirements of section 162, section 
167, or other relevant provisions of the Code, connected with the 
conduct of that activity and are deductible in computing unrelated 
business activities are directly connected with the conduct of that 
activity and are deductible in computing unrelated business taxable 
income if they otherwise qualify for deduction under the requirements of 
section 162. Similarly, depreciation of a building used entirely in the 
conduct of unrelated business activities would be an allowable deduction 
to the extent otherwise permitted by section 167.
    (c) Dual use of facilities or personnel. Where facilities are used 
both to carry on exempt activities and to conduct unrelated trade or 
business activities, expenses, depreciation and similar items 
attributable to such facilities (as, for example, items of overhead), 
shall be allocated between the two uses on a reasonable basis. 
Similarly, where personnel are used both to carry on exempt activities 
and to conduct unrelated trade or business activities, expenses and 
similar items attributable to such personnel (as, for example, items of 
salary) shall be allocated between the two uses on a reasonable basis. 
The portion of any such item so allocated to the unrelated trade or

[[Page 167]]

business activity is proximately and primarily related to that business 
activity, and shall be allowable as a deduction in computing unrelated 
business taxable income in the manner and to the extent permitted by 
section 162, section 167, or other relevant provisions of the Code. 
Thus, for example, assume that X, an exempt organization subject to the 
provisions of section 511, pays its president a salary of $20,000 a 
year. X derives gross income from the conduct of unrelated trade or 
business activities. The president devotes approximately 10 percent of 
his time during the year to the unrelated business activity. For 
purposes of computing X's unrelated business taxable income, a deduction 
of $2,000 (10 percent of $20,000), would be allowable for the salary 
paid to its president.
    (d) Exploitation of exempt activities--(1) In general. In certain 
cases, gross income is derived from an unrelated trade or business 
activity which exploits an exempt activity. One example of such 
exploitation is the sale of advertising in a periodical of an exempt 
organization which contains editorial material related to the 
accomplishment of the organization's exempt purpose. Except as specified 
in subparagraph (2) of this paragraph and paragraph (f) of this section, 
in such cases, expenses, depreciation and similar items attributable to 
the conduct of the exempt activities are not deductible in computing 
unrelated business taxable income. Since such items are incident to an 
activity which is carried on in furtherance of the exempt purpose of the 
organization, they do not possess the necessary proximate and primary 
relationship to the unrelated trade or business activity and are 
therefore not directly connected with that business activity.
    (2) Allowable deductions. Where an unrelated trade or business 
activity is of a kind carried on for profit by taxable organizations and 
where the exempt activity exploited by the business is a type of 
activity normally conducted by taxable organizations in pursuance of 
such business, expenses, depreciation, and similar items which are 
attributable to the exempt activity qualify as directly connected with 
the carrying on of the unrelated trade or business activity to the 
extent that:
    (i) The aggregate of such items exceeds the income (if any) derived 
from or attributable to the exempt activity; and
    (ii) The allocation of such excess to the unrelated trade or 
business activity does not result in a loss from such unrelated trade or 
business activity


Under the rule of the preceding sentence, expenses, depreciation and 
similar items paid or incurred in the performance of an exempt activity 
must be allocated first to the exempt activity to the extent of the 
income derived from or attributable to the performance of that activity. 
Furthermore, such items are in no event allocable to the unrelated trade 
or business activity exploiting such exempt activity to the extent that 
their deduction would result in a loss carryover or carryback with 
respect to that trade or business activity. Similarly, they may not be 
taken into account in computing unrelated business taxable income 
attributable to any unrelated trade or business activity not exploiting 
the same exempt activity. See paragraph (f) of this section for the 
application of these rules to periodicals published by exempt 
organizations.
    (e) Examples. This section is illustrated by the following examples:

    Example 1. W is an exempt business league with a large membership. 
Under an arrangement with an advertising agency W regularly mails 
brochures, pamphlets and other advertising materials to its members, 
charging the agency an agreed amount per enclosure. The distribution of 
the advertising materials does not contribute importantly to the 
accomplishment of the purpose for which W is granted exemption. 
Accordingly, the payments made to W by the advertising agency constitute 
gross income from an unrelated trade or business activity. In computing 
W's unrelated business taxable income, the expenses attributable solely 
to the conduct of the business, or allocable to such business under the 
rule of paragraph (c) of this section, are allowable as deductions in 
accordance with the provisions of section 162. Such deductions include 
the costs of handling and mailing, the salaries of personnel used full-
time in the unrelated business activity and an allocable portion of the 
salaries of personnel used both to carry on exempt activities and to 
conduct the unrelated business activity. However, costs of developing 
W's

[[Page 168]]

membership and carrying on its exempt activities are not deductible. 
Those costs are necessary to the maintenance of the intangible asset 
exploited in the unrelated business activity--W's membership--but are 
incurred primarily in connection with W's fundamental purpose as an 
exempt organization. As a consequence, they do not have proximate and 
primary relationship to the conduct of the unrelated business activity 
and do not qualify as directly connected with it.
    Example 2. (i) P, a manufacturer of photographic equipment, 
underwrites a photography exhibition organized by M, an art museum 
described in section 501(c)(3). In return for a payment of $100,000, M 
agrees that the exhibition catalog sold by M in connection with the 
exhibit will advertise P's product. The exhibition catalog will also 
include educational material, such as copies of photographs included in 
the exhibition, interviews with photographers, and an essay by the 
curator of M's department of photography. For purposes of this example, 
assume that none of the $100,000 is a qualified sponsorship payment 
within the meaning of section 513(i) and Sec. 1.513-4, that M's 
advertising activity is regularly carried on, and that the entire amount 
of the payment is unrelated business taxable income to M. Expenses 
directly connected with generating the unrelated business taxable income 
(i.e., direct advertising costs) total $25,000. Expenses directly 
connected with the preparation and publication of the exhibition catalog 
(other than direct advertising costs) total $110,000. M receives $60,000 
of gross revenue from sales of the exhibition catalog. Expenses directly 
connected with the conduct of the exhibition total $500,000.
    (ii) The computation of unrelated business taxable income is as 
follows:

(A) Unrelated trade or business (sale of
 advertising):
    Income.......................................   $100,000   .........
    Directly-connected expenses..................    (25,000)  .........
                                                  ----------------------
      Subtotal...................................     75,000    $75,000
                                                  ======================
(B) Exempt function (publication of exhibition
 catalog):
    Income (from catalog sales)..................     60,000   .........
    Directly-connected expenses..................   (110,000)  .........
                                                  ----------------------
      Net exempt function income (loss)..........    (50,000)   (50,000)
                                                  ======================
      Unrelated business taxable income..........  ..........    25,000
 

    (iii) Expenses related to publication of the exhibition catalog 
exceed revenues by $50,000. Because the unrelated business activity (the 
sale of advertising) exploits an exempt activity (the publication of the 
exhibition catalog), and because the publication of editorial material 
is an activity normally conducted by taxable entities that sell 
advertising, the net loss from the exempt publication activity is 
allowed as a deduction from unrelated business income under paragraph 
(d)(2) of this section. In contrast, the presentation of an exhibition 
is not an activity normally conducted by taxable entities engaged in 
advertising and publication activity for purposes of paragraph (d)(2) of 
this section. Consequently, the $500,000 cost of presenting the 
exhibition is not directly connected with the conduct of the unrelated 
advertising activity and does not have a proximate and primary 
relationship to that activity. Accordingly, M has unrelated business 
taxable income of $25,000.

    (f) Determination of unrelated business taxable income derived from 
sale of advertising in exempt organization periodicals--(1) In general. 
Under section 513 (relating to the definition of unrelated trade or 
business) and Sec. 1.513-1, amounts realized by an exempt organization 
from the sale of advertising in a periodical constitute gross income 
from an unrelated trade or business activity involving the exploitation 
of an exempt activity; namely, the circulation and readership of the 
periodical developed through the production and distribution of the 
readership content of the periodical. Paragraph (d) of this section 
provides for the allowance of deductions attributable to the production 
and distribution of the readership content of the periodical. Thus, 
subject to the limitations of paragraph (d)(2) of this section, where 
the circulation and readership of an exempt organization periodical are 
utilized in connection with the sale of advertising in the periodical, 
expenses, depreciation, and similar items of deductions attributable to 
the production and distribution of the editorial or readership content 
of the periodical shall qualify as items of deductions directly 
connected with the unrelated advertising activity. Subparagraphs (2) 
through (6) of this paragraph provide rules for determining the amount 
of unrelated business taxable income attributable to the sale of 
advertising in exempt organization periodicals. Subparagraph (7) of this 
paragraph provides rules for determining when the unrelated business 
taxable income of two or more exempt organization periodicals may be 
determined on a consolidated basis.

[[Page 169]]

    (2) Computation of unrelated business taxable income attributable to 
sale of advertising--(i) Excess advertising costs. If the direct 
advertising costs of an exempt organization periodical (determined under 
subparagraph (6)(ii) of this paragraph) exceed gross advertising income 
(determined under subparagraph (3)(ii) of this paragraph), such excess 
shall be allowable as a deduction in determining unrelated business 
taxable income from any unrelated trade or business activity carried on 
by the organization.
    (ii) Excess advertising income. If the gross advertising income of 
an exempt organization periodical exceeds direct advertising costs, 
paragraph (d)(2) of this section provides that items of deduction 
attributable to the production and distribution of the readership 
content of an exempt organization periodical shall qualify as items of 
deduction directly connected with unrelated advertising activity in 
computing the amount of unrelated business taxable income derived from 
the advertising activity to the extent that such items exceed the income 
derived from or attributable to such production and distribution, but 
only to the extent that such items do not result in a loss from such 
advertising activity. Furthermore, such items of deduction shall not 
qualify as directly connected with such advertising activity to the 
extent that their deduction would result in a loss carryback or 
carryover with respect to such advertising activity. Similarly, such 
items of deduction shall not be taken into account in computing 
unrelated business taxable income attributable to any unrelated trade or 
business activity other than such advertising activity. Thus:
    (a) If the circulation income of the periodical (determined under 
subparagraph (3)(iii) of this paragraph) equals or exceeds the 
readership costs of such periodical (determined under subparagraph 
(6)(iii) of this paragraph), the unrelated business taxable income 
attributable to the periodical is the excess of the gross advertising 
income of the periodical over direct advertising costs; but
    (b) If the readership costs of an exempt organization periodical 
exceed the circulation income of the periodical, the unrelated business 
taxable income is the excess, if any, of the total income attributable 
to the periodical (determined under subparagraph (3) of this paragraph) 
over the total periodical costs (as defined in subparagraph (6)(i) of 
this paragraph)


See subparagraph (7) of this paragraph for rules relating to the 
consolidation of two or more periodicals.
    (iii) Examples. The application of this paragraph may be illustrated 
by the following examples. For purposes of these examples it is assumed 
that the production and distribution of the readership content of the 
periodical is related to the organization's exempt purpose.

    Example 1. X, an exempt trade association, publishes a single 
periodical which carries advertising. During 1971, X realizes a total of 
$40,000 from the sale of advertising in the periodical (gross 
advertising income) and $60,000 from the sales of the periodical to 
members and nonmembers (circulation income). The total periodical costs 
are $90,000 of which $50,000 is directly connected with the sale and 
publication of advertising (direct advertising costs) and $40,000 is 
attributable to the production and distribution of the readership 
content (readership costs). Since the direct advertising costs of the 
periodical ($50,000) exceed gross advertising income ($40,000), pursuant 
to subdivision (i) of this subparagraph, the unrelated business taxable 
income attributable to advertising is determined solely on the basis of 
the income and deductions directly connected with the production and 
sale of the advertising:

Gross advertising revenue..................................      $40,000
Direct advertising costs...................................     (50,000)
                                                            ------------
Loss attributable to advertising...........................     (10,000)
                                                            ============
 


X has realized a loss of $10,000 from its advertising activity. This 
loss is an allowable deduction in computing X's unrelated business 
taxable income derived from any other unrelated trade or business 
activity.
    Example 2. Assume the facts as stated in example 1, except that the 
circulation income of X periodical is $100,000 instead of $60,000, and 
that of the total periodical costs, $25,000 are direct advertising 
costs, and $65,000 are readership costs. Since the circulation income 
($100,000) exceeds the total readership costs ($65,000), pursuant to 
subdivision (ii)(a) of this subparagraph the unrelated business taxable 
income attributable to the advertising activity is $15,000, the excess 
of gross advertising income ($40,000) over direct advertising costs 
($25,000).

[[Page 170]]

    Example 3. Assume the facts as stated in example 1, except that of 
the total periodical costs, $20,000 are direct advertising costs and 
$70,000 are readership costs. Since the readership costs of the 
periodical ($70,000), exceed the circulation income ($60,000), pursuant 
to subdivision (ii) (b) of this subparagraph the unrelated business 
taxable income attributable to advertising is the excess of the total 
income attributable to the periodical over the total periodical costs. 
Thus, X has unrelated business taxable income attributable to the 
advertising activity of $10,000 ($100,000 total income attributable to 
the periodical less $90,000 total periodical costs).
    Example 4. Assume the facts as stated in example 1, except that the 
total periodical costs are $120,000 of which $30,000 are direct 
advertising costs and $90,000 are readership costs. Since the readership 
costs of the periodical ($90,000), exceed the circulation income 
($60,000), pursuant to subdivision (ii) (b) of this subparagraph the 
unrelated business taxable income attributable to advertising is the 
excess, if any, of the total income attributable to the periodical over 
the total periodical costs. Since the total income of the periodical 
($100,000) does not exceed the total periodical costs ($120,000), X has 
not derived any unrelated business taxable income from the advertising 
activity. Further, only $70,000 of the $90,000 of readership costs may 
be deducted in computing unrelated business taxable income since as 
provided in subdivision (ii) of this subparagraph, such costs may be 
deducted, to the extent they exceed circulation income, only to the 
extent they do not result in a loss from the advertising activity. Thus, 
there is no loss from such activity, and no amount may be deducted on 
this account in computing X's unrelated trade or business income derived 
from any other unrelated trade or business activity.

    (3) Income attributable to exempt organization periodicals--(i) In 
general. For purposes of this paragraph the total income attributable to 
an exempt organization periodical is the sum of its gross advertising 
income and its circulation income.
    (ii) Gross advertising income. The term gross advertising income 
means all amounts derived from the unrelated advertising activities of 
an exempt organization periodical (or for purposes of this paragraph in 
the case of a taxable organization, all amounts derived from the 
advertising activities of the taxable organization).
    (iii) Circulation income. The term circulation income means the 
income attributable to the production, distribution or circulation of a 
periodical (other than gross advertising income) including all amounts 
realized from or attributable to the sale or distribution of the 
readership content of the periodical, such as amounts realized from 
charges made for reprinting or republishing articles and special items 
in the periodical and amounts realized from sales of back issues. Where 
the right to receive an exempt organization periodical is associated 
with membership or similar status in such organization for which dues, 
fees or other charges are received (hereinafter referred to as 
membership receipts), circulation income includes the portion of such 
membership receipts allocable to the periodical (hereinafter referred to 
as allocable membership receipts). Allocable membership receipts is the 
amount which would have been charged and paid if:
    (a) The periodical was that of a taxable organization.
    (b) The periodical was published for profit, and
    (c) The member was an unrelated party dealing with the taxable 
organization at arm's length


See subparagraph (4) of this paragraph for a discussion of the factors 
to be considered in determining allocable membership receipts of an 
exempt organization periodical under the standard described in the 
preceding sentence.
    (4) Allocable membership receipts. The allocable membership receipts 
of an exempt organization periodical shall be determined in accordance 
with the following rules:
    (i) Subscription price charged to nonmembers. If 20 percent or more 
of the total circulation of a periodical consist of sales to nonmembers, 
the subscription price charged to such nonmembers shall determine the 
price of the periodical for purposes of allocating membership receipts 
to the periodical.
    (ii) Subscription price to nonmembers. If paragraph (f)(4)(i) of 
this section does not apply and if the membership dues from 20 percent 
or more of the members of an exempt organization are less than those 
received from the other members because the former members do not 
receive the periodical, the amount of the reduction in membership dues 
for a member not receiving the periodical shall determine the price

[[Page 171]]

of the periodical for purposes of allocating membership receipts to the 
periodical.
    (iii) Pro rata allocation of membership receipts. Since it may 
generally be assumed that membership receipts and gross advertising 
income are equally available for all the exempt activities (including 
the periodical) of the organization, the share of membership receipts 
allocated to the periodical, where paragraphs (f)(4) (i) and (ii) of 
this section do not apply, shall be an amount equal to the 
organization's membership receipts multiplied by a fraction the 
numerator of which is the total periodical costs and the denominator of 
which is such costs plus the cost of other exempt activities of the 
organization. For example, assume that an exempt organization has total 
periodical costs of $30,000 and other exempt costs of $70,000. Further 
assume that the membership receipts of the organization are $60,000 and 
that paragraphs (f)(4) (i) and (ii) of this section do not apply. Under 
these circumstances $18,000 ($60,000 times $30,000/$100,000) is 
allocated to the periodical's circulation income.
    (5) Examples. The rules set forth in paragraph (f)(4) of this 
section may be illustrated by the following examples. For purposes of 
these examples it is assumed that the exempt organization periodical 
contains advertising, and that the production and distribution of the 
readership content of the periodical is related to the organization's 
exempt purpose.

    Example 1. U is an exempt scientific organization with 10,000 
members who pay annual dues of $15 per year. One of U's activities is 
the publication of a monthly periodical which is distributed to all of 
its members. U also distributes 5,000 additional copies of its 
periodical to nonmember subscribers at a cost of $10 per year. Pursuant 
to paragraph (f)(4)(i) of this section, since the nonmember circulation 
of U's periodical represents 33\1/3\ percent of its total circulation 
the subscription price charged to nonmembers will be used to determine 
the portion of U's membership receipts allocable to the periodical. 
Thus, U's allocable membership receipts will be $100,000 ($10 times 
10,000 members), and U's total circulation income for the periodical 
will be $150,000 ($100,000 from members plus $50,000 from sales to 
nonmembers).
    Example 2. Assume the facts as stated in example 1, except that U 
sells only 500 copies of its periodical to nonmembers, at a price of $10 
per year. Assume further that U's members may elect not to receive the 
periodical, in which case their annual dues are reduced from $15 per 
year to $6 per year, and that only 3,000 members elect to receive the 
periodical and pay the full dues of $15 per year. U's stated 
subscription price to members of $9 consistently results in an excess of 
total income (including gross advertising income) attributable to the 
periodical over total costs of the periodical. Since the 500 copies of 
the periodical distributed to nonmembers represents only 14 percent of 
the 3,500 copies distributed, pursuant to paragraph (f)(4)(i) of this 
section, the $10 subscription price charged to nonmembers will not be 
used in determining the portion of membership receipts allocable to the 
periodical. On the other hand, since 70 percent of the members elect not 
to receive the periodical and pay $9 less per year in dues, pursuant to 
paragraph (f)(4)(ii) of this section, such $9 price will be used in 
determining the subscription price charged to members. Thus, the 
allocable membership receipts will be $9 per member, or $27,000 ($9 
times 3,000 copies) and U's total circulation income will be $32,000 
($27,000 plus $5,000).
    Example 3. (a) W, an exempt trade association, has 800 members who 
pay annual dues of $50 per year. W publishes a monthly journal the 
editorial content and advertising of which are directed to the business 
interests of its own members. The journal is distributed to all of W's 
members and no receipts are derived from nonmembers.
    (b) W has total receipts of $100,000 of which $40,000 ($50x800) are 
membership receipts and $60,000 are gross advertising income. W's total 
costs for the journal and other exempt activities is $100,000. W has 
total periodical costs of $76,000 of which $41,000 are direct 
advertising costs and $35,000 are readership costs.
    (c) Paragraph (f)(4)(i) of this section will not apply since no 
copies are available to nonmembers. Therefore, the allocation of 
membership receipts shall be made in accordance with paragraph 
(f)(4)(iii) of this section. Based upon pro rata allocation of 
membership receipts (40,000) by a fraction the numerator of which is 
total periodical costs ($76,000) and the denominator of which is the 
total costs of the journal and the other exempt activities ($100,000), 
$30,400 ($76,000/$100,000 times $40,000) of membership receipts is 
circulation income.

    (6) Deductions attributable to exempt organization periodicals--(i) 
In general. For purposes of this paragraph the term total periodical 
costs means the total deductions attributable to the periodical. For 
purposes of this paragraph the total periodical costs of an exempt

[[Page 172]]

organization periodical are the sum of the direct advertising costs of 
the periodical (determined under subdivision (ii) of this subparagraph) 
and the readership costs of the periodical (determined under subdivision 
(iii) of this subparagraph). Items of deduction properly attributable to 
exempt activities other than the publication of an exempt organization 
periodical may not be allocated to such periodical. Where items are 
attributable both to an exempt organization periodical and to other 
activities of an exempt organization, the allocation of such items must 
be made on a reasonable basis which fairly reflects the portion of such 
item properly attributable to each such activity. The method of 
allocation will vary with the nature of the item, but once adopted, a 
reasonable method of allocation with respect to an item must be used 
consistently. Thus, for example, salaries may generally be allocated 
among various activities on the basis of the time devoted to each 
activity; occupancy costs such as rent, heat and electricity may be 
allocated on the basis of the portion of space devoted to each activity; 
and depreciation may be allocated on the basis of space occupied and the 
portion of the particular asset utilized in each activity. Allocations 
based on dollar receipts from various exempt activities will generally 
not be reasonable since such receipts are usually not an accurate 
reflection of the costs associated with activities carried on by exempt 
organizations.
    (ii) Direct advertising costs. (a) The direct advertising costs of 
an exempt organization periodical include all expenses, depreciation, 
and similar items of deduction which are directly connected with the 
sale and publication of advertising as determined in accordance with 
paragraphs (a), (b), and (c) of this section. These items are allowable 
as deductions in the computation of unrelated business income of the 
organization for the taxable year to the extent they meet the 
requirements of section 162, section 167, or other relevant provisions 
of the Code. The items allowable as deductions under this subdivision do 
not include any items of deduction attributable to the production or 
distribution of the readership content of the periodical.
    (b) The items allowable as deductions under this subdivision would 
include agency commissions and other direct selling costs, such as 
transportation and travel expenses, office salaries, promotion and 
research expenses, and direct office overhead directly connected with 
the sale of advertising lineage in the periodical. Also included would 
be other items of deduction commonly classified as advertising costs 
under standard account classification, such as art work and copy 
preparation, telephone, telegraph, postage, and similar costs directly 
connected with advertising.
    (c) In addition to the items of deduction normally included in 
standard account classifications relating to advertising costs, it is 
also necessary to ascertain the portion of mechanical and distribution 
costs attributable to advertising lineage. For this purpose, the general 
account classifications of items includible in mechanical and 
distribution costs ordinarily employed in business-paper and consumer 
publication accounting provide a guide for the computation. Thus, the 
mechanical and distribution costs in such cases would include the 
portion of the costs and other expenses of composition, presswork, 
binding, mailing (including paper and wrappers used for mailing), and 
the bulk postage attributable to the advertising lineage of the 
publication. The portion of mechanical and distribution costs 
attributable to advertising lineage of the periodical will be determined 
on the basis of the ratio of advertising lineage to total lineage of the 
periodical, and the application of that ratio to the total mechanical 
and distribution costs of the periodical, where records are not kept in 
such a manner as to reflect more accurately the allocation of mechanical 
and distributions costs to advertising lineage of the periodical, and 
where there is no factor in the character of the periodical to indicate 
that such an allocation would be unreasonable.
    (iii) Readership costs. The readership costs of an exempt 
organization periodical include expenses, depreciation or similar items 
which are directly connected with the production and distribution of the 
readership content of

[[Page 173]]

the periodical and which would otherwise be allowable as deductions in 
determining unrelated business taxable income under section 512 and the 
regulations thereunder if such production and distribution constituted 
an unrelated trade or business activity. Thus, readership costs include 
all the items of deduction attributable to an exempt organization 
periodical which are not allocated to direct advertising costs under 
subdivision (ii) of this subparagraph, including the portion of such 
items attributable to the readership content of the periodical, as 
opposed to the advertising content, and the portion of mechanical and 
distribution costs which is not attributable to advertising lineage in 
the periodical.
    (7) Consolidation--(i) In general. Where an exempt organization 
subject to unrelated business income tax under section 511 publishes two 
or more periodicals for the production of income, it may treat the gross 
income from all (but not less than all) of such periodicals and the 
items of deduction directly connected with such periodicals (including 
readership costs of such periodicals), on a consolidated basis as if 
such periodicals were one periodical in determining the amount of 
unrelated business taxable income derived from the sale of advertising 
in such periodical. Such treatment must, however, be followed 
consistently and once adopted shall be binding unless the consent of the 
Commissioner is obtained as provided in sections 446(e) and Sec. 1.446-
1(e).
    (ii) Production of income. For purposes of this subparagraph, an 
exempt organization periodical is published for the production of income 
if:
    (a) The organization generally receives gross advertising income 
from the periodical equal to at least 25 percent of the readership costs 
of such periodical, and
    (b) The publication of such periodical is an activity engaged in for 
profit


For purposes of the preceding sentence, the determination whether the 
publication of a periodical is an activity engaged in for profit is to 
be made by reference to objective standards taking into account all the 
facts and circumstances involved in each case. The facts and 
circumstances must indicate that the organization carries on the 
activity with the objective that the publication of the periodical will 
result in economic profit (without regard to tax consequences), although 
not necessarily in a particular year. Thus, an exempt organization 
periodical may be treated as having been published with such an 
objective even though in a particular year its total periodical costs 
exceed its total income. Similarly, if an exempt organization begins 
publishing a new periodical, the fact that the total periodical costs 
exceed the total income for the startup years because of a lack of 
advertising sales does not mean that the periodical was published 
without an objective of economic profit. The organization may establish 
that the activity was carried on with such an objective. This might be 
established by showing, for example, that there is a reasonable 
expectation that the total income, by reason of an increase in 
advertising sales, will exceed costs within a reasonable time. See Sec. 
1.183-2 for additional factors bearing on this determination.
    (iii) Example. This subparagraph may be illustrated by the following 
example:

    Example. Y, an exempt trade association, publishes three periodicals 
which it distributes to its members: a weekly newsletter, a monthly 
magazine, and quarterly journal. Both the monthly magazine and the 
quarterly journal contain advertising which accounts for gross 
advertising income equal to more than 25 percent of their respective 
readership costs. Similarly, the total income attributable to each such 
periodical has exceeded the total deductions attributable to each such 
periodical for substantially all the years they have been published. The 
newsletter carries no advertising and its annual subscription price is 
not intended to cover the cost of publication. The newsletter is a 
service of Y distributed to all of its members in an effort to keep them 
informed of changes occurring in the business world and is not engaged 
in for profit. Under these circumstances, Y may consolidate the income 
and deductions from the monthly and quarterly journals in computing its 
unrelated business taxable income, but may not consolidate the income 
and deductions attributable to the publication of the newsletter with 
the income and deductions of its other periodicals since the newsletter 
is not published for the production of income.


[[Page 174]]


    (g) Foreign organizations--(1) In general. The unrelated business 
taxable income of a foreign organization exempt from taxation under 
section 501(a) consists of:
    (i) The organization's unrelated business taxable income which is 
derived from sources within the United States but which is not 
effectively connected with the conduct of a trade or business within the 
United States, plus
    (ii) The organization's unrelated business taxable income 
effectively connected with the conduct of a trade or business within the 
United States (whether or not such income is derived from sources within 
the United States)


To determine whether income realized by a foreign organization is 
derived from sources within the United States or is effectively 
connected with the conduct of a trade or business within the United 
States, see part 1, subchapter N, chapter 1 of the Code (section 861 and 
following) and the regulations thereunder.
    (2) Effective dates. Subparagraph (1) of this paragraph applies to 
taxable years beginning after December 31, 1969. For taxable years 
beginning on or before December 31, 1969, the unrelated business taxable 
income of a foreign organization exempt from taxation under section 
501(a) consists of the organization's unrelated business taxable income 
which:
    (i) For taxable years beginning after December 31, 1966, is 
effectively connected with the conduct of a trade or business within the 
United States, whether or not such income is derived from sources within 
the United States;
    (ii) For taxable years beginning on or before December 31, 1966, is 
derived from sources within the United States.
    (h) Effective date. Paragraphs (a) through (f) of this section are 
applicable with respect to taxable years beginning after December 12, 
1967. However, if a taxpayer wishes to rely on the rules stated therein 
for taxable years beginning before December 13, 1967, he may do so.

[T.D. 7392, 40 FR 58638, Dec. 18, 1975, as amended by T.D. 7438, 41 FR 
44392, Oct. 8, 1976; T.D. 7935, 49 FR 1694, Jan. 13, 1984; T.D. 8991, 67 
FR 20437, Apr. 25, 2002]



Sec. 1.512(a)-2  Definition applicable to taxable years beginning before 

December 13, 1967.

    (a) In general. The unrelated business taxable income which is 
subject to the tax imposed by section 511 is the gross income, derived 
by any organization to which section 511 applies, from any unrelated 
trade or business regularly carried on by it, less the deductions 
allowed by chapter 1 of the Code which are directly connected with the 
carrying on of such trade or business, subject to certain exceptions, 
additions, and limitations referred to below. In the case of an 
organization which regularly carries on two or more unrelated 
businesses, its unrelated business taxable income is the aggregate of 
its gross income from all such unrelated businesses, less the aggregate 
of the deductions allowed with respect to all such unrelated businesses. 
For provisions generally applicable to the unrelated business tax, see 
Sec. 1.511-3, and for rules applicable to the determination of the 
adjusted basis of property, see paragraph (a)(2) of Sec. 1.514(a)-1.
    (b) Effective date. Except as provided in paragraph (f) of Sec. 
1.512(a)-1, this section is applicable with respect to taxable years 
beginning before December 13, 1967.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6939, 32 FR 
17660, Dec. 12, 1967]



Sec. 1.512(a)-3  [Reserved]



Sec. 1.512(a)-4  Special rules applicable to war veterans organizations.

    (a) In general. For taxable years beginning after December 31, 1969, 
this section provides special rules for the determination of the 
unrelated business taxable income of an organization described in 
section 501(c)(19). In general, the rules contained in sections 511 
through 514 which are applicable to any organization listed in section 
501(c) apply in determining the unrelated business taxable income of an 
organization described in section 501(c)(19). However, that amount which 
is paid by members to the organization for the purpose described in 
paragraph (b)(1) of this section, if set aside from other organizational 
monies and accounts in an insurance set aside, may be excluded

[[Page 175]]

from the unrelated business taxable income of the organization. The 
insurance set aside shall be used exclusively for providing insurance 
benefits, for the purposes specified in section 170(c)(4) of the Code, 
for the reasonable costs of administering the insurance program that are 
directly related to such set aside, or for the reasonable costs of 
distributing funds for section 170(c)(4) purposes. If an amount so set 
aside is used for any purposes other than those described in the 
preceding sentence, it shall be included in unrelated business taxable 
income without regard to any modifications provided by section 512(b), 
in the taxable year in which it is withdrawn from such set aside. 
Amounts will be considered to have been withdrawn from an insurance set 
aside if they are used in any manner inconsistent with providing 
insurance benefits, paying the reasonable costs of administering the 
insurance program for section 170(c)(4) purposes and for costs of 
distributing funds for section 170(c)(4) purposes. An example of a use 
of funds which would be considered a withdrawal would be the use of such 
funds as security for a loan.
    (b) Insurance set aside--(1) Purpose of payments by members. 
Payments by members (including commissions on such payments earned by 
the set aside as agent for an insurance company) into an insurance set 
aside must be for the sole purpose of obtaining life, sick, accident or 
health insurance benefits from the organization or for the reasonable 
costs of administration of the insurance program, except that such 
purpose is not violated when excess funds from an experience gain are 
utilized for those purposes specified in section 170(c)(4) or the 
reasonable costs of distributing funds for such purposes. Funds for any 
other purpose may not be set aside in the insurance set aside.
    (2) Income from set aside. In addition to the payments by members 
described in paragraph (b)(1) of this section, only income from amounts 
in the insurance set aside (including commissions earned as agent for an 
insurance company) may be so set aside. Moreover unless such income is 
used for providing insurance benefits, for those purposes specified in 
section 170(c)(4), or for reasonable costs of administration, such 
income must be set aside within the period described in paragraph (b)(3) 
of this section in order to avoid being included as an item of unrelated 
business taxable income under section 512(a)(4).
    (3) Time within which income must be set aside. Income from amounts 
in the insurance set aside generally must be set aside in the taxable 
year in which it would be includible in gross income but for this 
section. However, income set aside on or before the date prescribed for 
filing the organization's return of unrelated business taxable income 
(whether or not it had such income) for the taxable year (including any 
extension of time) may, at the election of the organization, be treated 
as having been set aside in such taxable year.
    (4) Computation of income from set aside. Income from amounts in the 
insurance set aside shall consist solely of items of investment income 
from, and other gains derived from dealings in, property in the set 
aside. The deductions allowed against such items of income or other 
gains are those amounts which are related to the production of such 
income or other gains. Only the amounts of income or other gain which 
are in excess of such deductions may be set aside in the insurance set 
aside.
    (5) Requirements for set aside. An amount is not properly set aside 
if the organization commingles it with any amount which is not to be set 
aside. However, adequate records describing the amount set aside and 
indicating that it is to be used for the designated purpose are 
sufficient. Amounts that are set aside need not be permanently committed 
to such use either under state law or by contract. Thus, for example, it 
is not necessary that the organization place these funds in an 
irrevocable trust. Although set aside income may be accumulated, any 
accumulation which is unreasonable in amount or duration is evidence 
that the income was not accumulated for the purposes set forth. For 
purposes of the preceding sentence, accumulations which are reasonably 
necessary for the purpose of providing life, sick, health, or accident 
insurance benefits on the

[[Page 176]]

basis of recognized mortality or morbidity tables and assumed rates of 
interest under an actuarially acceptable method would not be 
unreasonable even though such accumulations are quite large and the time 
between the receipt by the organization of such amounts and the date of 
payment of the benefits is quite long. For example, an accumulation of 
income for 20 years or longer which is determined to be reasonable 
necessary to pay life insurance benefits to members, their dependents or 
designated beneficiaries, generally would not be an unreasonable 
accumulation. Income which has been set aside may be invested, pending 
the action contemplated by the set aside, without being regarded as 
having been used for other purposes.

[T.D. 7438, 41 FR 44393, Oct. 8, 1976]



Sec. 1.512(a)-5T  Questions and answers relating to the unrelated business 

taxable income of organizations described in paragraphs (9), (17) or (20) of 

Section 501(c) (temporary).

    Q-1: What does section 512(a)(3), as amended by the Tax Reform Act 
of 1984 (Act), provide with respect to organizations described in 
paragraphs (9), (17) or (20) of section 501(c)?
    A-1: In general, section 512(a)(3), as amended by section 511 of the 
Act, extends the rules for determining the unrelated business income tax 
of voluntary employees' beneficiary associations (VEBAs) to supplemental 
unemployment compensation benefit trusts (SUBs) and group legal service 
organizations (GLSOs). The section also restricts the amount of income 
that may be set aside by such organizations for exempt purposes.
    Q-2: What is the effective date of the amendments to section 
512(a)(3)?
    A-2: The amendments to section 512(a)(3) will apply to income earned 
by VEBAs, SUBs or GLSOs after December 31, 1985, in the taxable years of 
such organizations ending after such date. For purposes of applying 
section 512(a)(3) to the first taxable year of such an organization 
ending after December 31, 1985, the income of the VEBA, SUB or GLSO 
earned after December 31, 1985, will be determined by allocating the 
total income earned for such taxable year on the basis of the calendar 
year 1985 and 1986 months in such taxable year. However, if a VEBA, SUB 
or GLSO is part of a plan that is maintained pursuant to one or more 
collective bargaining agreements (a) between employee representatives 
and one or more employers, and (b) which are in effect on July 1, 1985 
(or ratified on or before that date), the amendments do not apply to 
income earned in a taxable year of a VEBA, SUB or GLSO beginning before 
the termination of the last of the collective bargaining agreements 
pursuant to which the plan is maintained (determined without regard to 
any extension of the contract agreed to after July 1, 1985). For 
purposes of the preceding sentence, any plan amendment made pursuant to 
a collective bargaining agreement relating to the plan which amends the 
plan solely to conform to any requirement added under section 511 of the 
Tax Reform Act 1984 (i.e., requirements under section 419, 419A, 
512(a)(3)(E), and 4976) shall not be treated as a termination of such 
collective bargaining agreements.
    Q-3: What amount of income may a VEBA, SUB or GLSO set aside for 
exempt purposes?
    A-3: (a) Pursuant to section 512(a)(3)(E)(i), the amounts set aside 
in a VEBA, SUB, or GLSO (including a VEBA, SUB, or GLSO that is part of 
a 10 or more employer plan, as defined in section 419A(f)(6)(B)) as of 
the close of a taxable year of such VEBA, SUB, or GLSO to provide for 
the payment of life, sick, accident, or other benefits may not be taken 
into account for purposes of determining exempt function income to the 
extent that such amounts exceed the qualified asset account limit, 
determined under sections 419A(c) and 419A(f)(7), for such taxable year 
of the VEBA, SUB, or GLSO. In calculating the qualified asset account 
limit for this purpose, a reserve for post-retirement medical benefits 
under section 419A(c)(2)(A) is not to be taken into account.
    (b) The exempt function income of a VEBA, SUB, or GLSO for a taxable 
year of such an organization, under section 512(a)(3)(B), includes: (1) 
Certain amounts paid by members of the VEBA, SUB, or GLSO within the 
meaning of the first sentence of section 512(a)(3)(B) (member 
contributions); and (2) other income of the VEBA, SUB, or GLSO 
(including earnings on member contributions) that is set aside for the 
payment of life, sick, accident, or other benefits to the extent that 
the total amount set aside in the VEBA, SUB or GLSO as of the close of 
the taxable year for any purpose (including member contributions and 
other income set aside in the VEBA, SUB, or GLSO as of the close of the 
year) does not exceed the qualified asset account limit for such taxable 
year of the organization. For purposes of section 512(a)(3)(B), member 
contributions include both employee contributions and employer 
contributions to the VEBA, SUB, or GLSO. In calculating the total amount 
set aside in a VEBA, SUB, or GLSO as of the close of a taxable year, 
certain assets with useful lives extending substantially beyond the end 
of the taxable year (e.g., buildings, and licenses) are not to be taken 
into account to the extent they are used in the provision of life, sick, 
accident,

[[Page 177]]

or other benefits. For example, cash and securities (and similar 
investments) held by a VEBA, SUB or GLSO are not disregarded in 
calculating the total amount set aside for this purpose because they are 
used to pay welfare benefits, rather than merely used in the provision 
of such benefits. Accordingly, the unrelated business taxable income of 
a VEBA, SUB, or GLSO for a taxable year of such an organization 
generally will equal the lesser of two amounts: the income of the VEBA, 
SUB, or GLSO for the taxable year (excluding member contributions); or, 
the excess of the total amount set aside as of the close of the taxable 
year (including member contributions, and excluding certain assets with 
a useful life extending substantially beyond the end of the taxable year 
to the extent they are used in the provision of welfare benefits) over 
the qualified asset account limit (calculated without regard to the 
otherwise permitted reserve for post-retirement medical benefits) for 
the taxable year. See Sec. 1.419A-2T for special rules relating to 
collectively bargained welfare benefit funds.
    (c) The income of a VEBA, SUB, or GLSO for any taxable year includes 
gain realized by the organization on the sale or disposition of any 
asset during such year. The gain realized by a VEBA, SUB, or GLSO on the 
sale or disposition of an asset is equal to the amount realized by the 
organization over the basis of such asset (in the hands of the 
organization), reduced by any qualified direct costs attributable to 
such asset (under paragraphs (b), (c), and (d) of Q&A-6 of Sec. 1.419-
1T).
    Q-4: What transition rules apply to existing reserves for post-
retirement medical or life insurance benefits?
    A-4: (a) Section 512(a)(3)(E)(iii)(I) provides that income that is 
either directly or indirectly attributable to existing reserves for 
post-retirement medical or life insurance benefits will not be treated 
as unrelated business taxable income. An existing reserve for post-
retirement medical or life insurance benefits (as defined in section 
512(a)(3)(E)(iii)(II)) is the total amount of assets actually set aside 
in a VEBA, SUB, or GLSO on July 18, 1984 (calculated in the manner set 
forth in Q&A-3 of the regulation, and adjusted under paragraph (c) of 
Q&A-11 of Sec. 1.419-1T), reduced by employer contributions to the fund 
on or before such date to the extent such contributions are not 
deductible for the taxable year of the employer containing July 18, 
1984, and for any prior taxable year of the employer, for purposes of 
providing such post-retirement benefits. For purposes of the preceding 
sentence only, an amount that was not actually set aside on July 18, 
1984, will be treated as having been actually set aside on such date if 
(1) such amount was incurred by the employer (without regard to section 
461(h)) as of the close of the last taxable year of the VEBA, SUB, or 
GLSO ending before July 18, 1984, and (2) such amount was actually 
contributed to the VEBA, SUB, or GLSO within 8\1/2\ months following the 
close of such taxable year.
    (b) In addition, section 512(a)(3)(E)(iii)(I) applies to existing 
reserves for such post-retirement benefits only to the extent that such 
existing reserves do not exceed the amount that could be accumulated 
under the principles set forth in Revenue Rulings 69-382, 1969-2, C.B. 
28; 69-478, 1969-2 C.B. 29; and 73-599, 1973-2 C.B. 40. Thus, amounts 
attributable to such excess existing reserves are not within this 
transition rule eventhough they were actually set aside on July 18, 
1984.
    (c) All post-retirement medical or life insurance benefits (or other 
benefits to the extent paid with amounts set aside to provide post-
retirement medical or life insurance benefits) provided after July 18, 
1984 (whether or not the employer has maintained a reserve or fund for 
such benefits) are to be charged, first, against the existing reserves 
within this transition rule (including amounts attributable to existing 
reserves within this transition rule) for post-retirement medical 
benefits or for post-retirement life insurance benefits (as the case may 
be) and, second, against all other amounts. For this purpose, the 
qualified direct cost of an asset with a useful life extending 
substantially beyond the end of the taxable year (as determined under 
Q&A-6 of Sec. 1.419-1T) will be treated as a benefit provided and thus 
charged against the existing reserve based on the extent to which such 
asset is used in the provision of post-retirement medical benefits or 
post-retirement life insurance benefits (as the case may be). All plans 
of an employer providing post-retirement medical benefits are to be 
treated as one plan for purposes of section 512(a)(3)(E)(iii)(III), and 
all plans of an employer providing post-retirement life insurance 
benefits are to be treated as one plan for purposes of section 
512(a)(3)(E)(iii)(III).
    (d) In calculating the unrelated business taxable income of a VEBA, 
SUB, or GLSO for a taxable year of such organization, the total income 
of the VEBA, SUB, or GLSO for the taxable year is reduced by the income 
attributable to existing reserves within the transition rule before such 
income is compared to the excess of the total amount set aside as of the 
close of the taxable year over the qualified asset account limit for the 
taxable year. Thus, for example, assume that the total income of a VEBA 
for a taxable year is $1,000, and that the excess of the total amount of 
the VEBA set aside as of the close of the taxable year over the 
applicable qualified asset account limit is $600. Assume also that of 
the $1,000 of total income, $500 is attributable to existing reserves 
within the transition rule of section 512(a)(3)(E)(iii)(I). The 
unrelated business income of this VEBA for the taxable year is equal to 
the lesser of the following two amounts: (1) the total income of the

[[Page 178]]

VEBA for the taxable year ($1,000), reduced to the extent that such 
income is attributable to existing reserves within the transition rule 
($500); or (2) the excess of the total amount set aside as of the close 
of the taxable year over the applicable qualified asset account limit 
($600). Thus, the unrelated business income of this VEBA for the taxable 
year is $500.

[T.D. 8073, 51 FR 4332, Feb. 4, 1986; 51 FR 7262, Mar. 3, 1986; 51 FR 
11303, April 2, 1986; T.D. 8073, 73 FR 59501, Oct. 9, 2008]



Sec. 1.512(b)-1  Modifications.

    Whether a particular item of income falls within any of the 
modifications provided in section 512(b) shall be determined by all the 
facts and circumstances of each case. For example, if a payment termed 
rent by the parties is in fact a return of profits by a person operating 
the property for the benefit of the tax-exempt organization or is a 
share of the profits retained by such organization as a partner or joint 
venturer, such payment is not within the modification for rents. The 
modifications provided in section 512(b) are as follows:
    (a) Certain Investment Income--(1) In general. Dividends, interest, 
payments with respect to securities loans (as defined in section 
512(a)(5)), annuities, income from notional principal contracts (as 
defined in Treasury Regulations 26 CFR 1.863-7 or regulations issued 
under section 446), other substantially similar income from ordinary and 
routine investments to the extent determined by the Commissioner, and 
all deductions directly connected with any of the foregoing items of 
income shall be excluded in computing unrelated business taxable income.
    (2) Limitations. The exclusions under paragraph (a)(1) of this 
section do not apply to income derived from and deductions in connection 
with debt-financed property (as defined in section 514(b)). Moreover, 
the exclusions under paragraph (a)(1) of this section do not apply to 
gains or losses from the sale, exchange, or other disposition of any 
property, or to gains or losses from the lapse or termination of options 
to buy or sell securities. For rules regarding the treatment of these 
gains and losses, see section 512(b)(5) and Sec. 1.512(b)-1(d). 
Furthermore, the exclusions under paragraph (a)(1) of this section do 
not apply to interest and annuities derived from and deductions in 
connection with controlled organizations. For rules regarding the 
treatment of such amounts, see section 512(b)(13) and Sec. 1.512(b)-
1(l). Finally, the exclusions under paragraph (a)(1) of this section of 
income from notional principal contracts and income that the 
Commissioner determines to be substantially similar income from ordinary 
and routine investments do not apply to income earned by brokers or 
dealers (including organizations that make a market in derivative 
financial products, as described in Treasury Regulations 26 CFR 1.954-
2T(a)(4)(iii)(B)).
    (3) Effective dates. The effective dates of the rules of paragraphs 
(a)(1) and (a)(2) of this section that were in effect prior to August 
30, 1991, remain the same. The exclusion under paragraph (a)(1) of this 
section of income from notional principal contracts is effective for 
amounts received after August 30, 1991. However, an organization may 
apply the exclusion under paragraph (a)(1) of this section of income 
from notional principal contracts prior to that date, provided that such 
amounts are treated consistently for all open taxable years. Unless 
otherwise provided by the Commissioner, the exclusion under paragraph 
(a)(1) of this section of income that the Commissioner determines to be 
substantially similar income from ordinary and routine investments is 
effective for amounts received after the date of the Commissioner's 
determination.
    (b) Royalties. Royalties, including overriding royalties, and all 
deductions directly connected with such income shall be excluded in 
computing unrelated business taxable income. However, for taxable years 
beginning after December 31, 1969, certain royalties from and certain 
deductions in connection with either, debt-financed property (as defined 
in section 514(b)) or controlled organizations (as defined in paragraph 
(l) of this section) shall be included in computing unrelated business 
taxable income. Mineral royalties shall be excluded whether measured by 
production or by gross or taxable income from the mineral property. 
However, where an organization owns a working interest in a mineral 
property,

[[Page 179]]

and is not relieved of its share of the development costs by the terms 
of any agreement with an operator, income received from such an interest 
shall not be excluded. To the extent not treated as a loan under section 
636, payments in discharge of mineral production payments shall be 
treated in the same manner as royalty payments for the purpose of 
computing unrelated business taxable income. To the extent treated as a 
loan under section 636, the amount of any payment in discharge of a 
production payment which is the equivalent of interest shall be treated 
as interest for purposes of section 512(b)(1) and paragraph (a) of this 
section.
    (c) Rents--(1) Taxable years beginning before January 1, 1970. For 
taxable years beginning before January 1, 1970, rents from real property 
(including personal property leased with the real property) and the 
deductions directly connected therewith shall be excluded in computing 
unrelated business taxable income, except that certain rents from, and 
certain deductions in connection with, a business lease (as defined in 
section 514(f)) shall be included in computing unrelated business 
taxable income. See subparagraph (5) of this paragraph for rules 
governing amounts received for the rendering of services.
    (2) Taxable years beginning after December 31, 1969--(i) In general. 
For taxable years beginning after December 31, 1969, except as provided 
in subdivision (iii) of this subparagraph, rents from property described 
in subdivision (ii) of this subparagraph, and the deductions directly 
connected therewith, shall be excluded in computing unrelated business 
taxable income. However, notwithstanding subdivision (ii) of this 
subparagraph, certain rents from and certain deductions in connection 
with either debt-financed property (as defined in section 514(b)) or 
property rented to controlled organizations (as defined in paragraph (l) 
of this section) shall be included in computing unrelated business 
taxable income.
    (ii) Excluded rents. The rents which are excluded from unrelated 
business income under section 512(b)(3)(A) and this paragraph are:
    (a) Real property. All rents from real property; and
    (b) Personal property. All rents from personal property leased with 
real property if the rents attributable to such personal property are an 
incidental amount of the total rents received or accrued under the 
lease, determined at the time sonal property are an incidental amount 
service by the lessee


For purposes of the preceding sentence, rents attributable to personal 
property generally are not an incidental amount of the total rents if 
such rents exceed 10 percent of the total rents from all the property 
leased. For example, if the rents attributable to the personal property 
leased are determined to be $3,000 per year, and the total rents from 
all property leased are $10,000 per year, then such $3,000 amount is not 
to be excluded from the computation of unrelated business taxable income 
by operation of section 512(b)(3)(A)(ii) and this paragraph, since such 
amount is not an incidental portion of the total rents.
    (iii) Exception. Subdivision (ii) of this subparagraph shall not 
apply, if either:
    (a) Excess personal property rents. More than 50 percent of the 
total rents are attributable to personal property, determined at the 
time such personal property is first placed in service by the lessee; or
    (b) Net profits. The determination of the amount of such rents 
depends in whole or in part on the income or profits derived by any 
person from the property leased, other than an amount based on a fixed 
percentage or percentages of the gross receipts or sales. For purposes 
of the preceding sentence, the rules contained in paragraph (b) (3) and 
(6) (other than paragraph (b)(6)(ii)) of Sec. 1.856-4 shall apply.
    (iv) Illustration. This subparagraph may be illustrated by the 
following example:

    Example. A, an exempt organization, owns a printing factory which 
consists of a building housing two printing presses and other equipment 
necessary for printing. On January 1, 1971, A rents the building and the 
printing equipment to B for $10,000 a year. The lease states that $9,000 
of such rent is for the building and $1,000 for the printing equipment. 
However, it is determined that notwithstanding the terms of the lease 
$4,000, or 40 percent ($4,000/$10,000), of the rent is actually 
attributable to the printing equipment. During 1971, A has $3,000 of 
deductions, all of

[[Page 180]]

which are properly allocable to the land and building. Under these 
circumstances, A shall not take into account in computing its unrelated 
business taxable income the $6,000 of rent attributable to the building 
and the $3,000 of deductions directly connected with such rent. However, 
the $4,000 of rent attributable to the printing equipment is not 
excluded from the computation of A's unrelated business taxable income 
by operation of section 512(b)(3)(A)(ii) or this paragraph since such 
rent represents more than an incidental portion of the total rents.

    (3) Definitions and special rules. For purposes of subparagraph (2) 
of this paragraph:
    (i) Real property defined. The term real property means all real 
property, including any property described in sections 1245(a)(3)(C) and 
1250(c) and the regulations thereunder.
    (ii) Personal property defined. The term personal property means all 
personal property, including any property described in section 
1245(a)(3)(B) and the regulations thereunder.
    (iii) Multiple leases. If separate leases are entered into with 
respect to real and personal property, and such properties have an 
integrated use (e.g., one or more leases for real property and another 
lease or leases for personal property to be used upon such real 
property), all such leases shall be considered as one lease.
    (iv) Placed in service. Property is placed in service by the lessee 
when it is first subject to his use in accordance with the terms of the 
lease. For example, property subject to a lease entered into on November 
1, 1971, for a term commencing on January 1, 1972, shall be considered 
as placed in service on January 1, 1972, regardless of when the property 
is first actually used by the lessee.
    (v) Changes in rent charged or personal property rented. If:
    (a) By reason of the placing of additional or substitute personal 
property in service, there is an increase of 100 percent or more in the 
rent attributable to all the personal property leased, or
    (b) There is a modification of the lease by which there is a change 
in the rent charged (whether or not there is a change in the amount of 
personal property rented), the rent attributable to personal property 
shall be recomputed to determine whether the exclusion under 
subparagraph (2)(ii)(b) of this paragraph or the exception under 
subparagraph (2)(iii)(a) of this paragraph applies. Any change in the 
treatment of rents, attributable to a recomputation under this 
subdivision, shall be effective only with respect to rents for the 
period beginning with the event which occasioned the recomputation.
    (4) Examples. Subparagraphs (2) and (3) of this paragraph may be 
illustrated by the following examples:

    Example 1. On January 1, 1971, A, an exempt organization, executes 
two leases with B. One is for the rental of a computer, with a stated 
annual rent of $750. The other is for the rental of office space in 
which to use the computer, at a stated annual rent of $7,250. The total 
annual rent under both leases for 1971 is $8,000. At the time the 
computer is first placed in service, however, taking both leases into 
consideration, it is determined that notwithstanding the terms of the 
leases $3,000, or 37.5 percent ($3,000/$8,000), of the rent is actually 
attributable to the computer. Therefore, for 1971, only the $5,000 
($8,000-$3,000) attributable to the rental of the office space is 
excluded from the computation of A's unrelated business taxable income 
by operation of section 512(b)(3).
    Example 2. Assume the facts as stated in example 1. Assume further 
that the leases to which the computer and office space are subject in 
example 1 provide that the rent may be increased or decreased, depending 
upon the prevailing rental value for similar computers and office space. 
On January 1, 1972, the total annual rent is increased in the computer 
lease to $2,000, and in the office space lease to $9,000. For 1972, it 
is determined that notwithstanding the terms of the leases $6,000, or 
54.5 percent ($6,000/$11,000), of the total rent is actually 
attributable to the computer as of that time. Even though the rent 
attributable to personal property now exceeds 50 percent of the total 
rent, the rent attributable to real property will continue to be 
excluded, since there was no modification of the terms of the leases and 
since the increase in the rent was not attributable to the placing of 
new personal property in service. See subparagraph (3)(v) of this 
paragraph. Thus, for 1972 the $5,000 of rent attributable to the office 
space continues to be excluded from the computation of A's unrelated 
business taxable income by operation of section 512(b)(3).
    Example 3. Assume the facts as stated in example 1, except that on 
January 1, 1973, B rents a second computer from A, which is placed in 
service on that date. The total rent is increased to $2,000 for the 
computer lease and to $10,000 for the office space lease. It is

[[Page 181]]

determined at the time the second computer is first placed in service 
that notwithstanding the terms of the leases $7,000 of the rent is 
actually attributable to the computers. Since the rent attributable to 
personal property has increased by more than 100 percent ($4,000/
$3,000=133 percent), a redetermination must be made pursuant to 
subparagraph (3)(v) (a) of this paragraph. As a result, 58.3 percent 
($7,000/$12,000) of the total rent is determined to be attributable to 
personal property. Accordingly, since more than 50 percent of the total 
rent A receives is attributable to the personal property leased, none of 
the rents are excluded from the computation of A's unrelated business 
taxable income by operation of section 512(b)(3).
    Example 4. Assume the facts as stated in example 3, except that on 
June 30, 1975, the lease between B and A is modified. The total rent for 
the computer lease is reduced to $1,500 and the total rent for the 
office space lease is reduced to $7,500. Pursuant to subdivision 
(3)(v)(b) of this paragraph, a redetermination is made as of June 30, 
1975. As of the modification date, it is determined that notwithstanding 
the terms of the leases, the rent actually attributable to the computers 
is $4,000, or 44.4 percent ($4,000/$9,000), of the total rent. Since 
less than 50 percent of the total rent is now attributable to personal 
property, the rent attributable to real property ($5,000), for periods 
after June 30, 1975, is excluded from the computation of A's unrelated 
business taxable income by operation of section 512(b)(3). However, the 
rent attributable to personal property ($4,000) is not excluded from 
unrelated business taxable income for such periods by operation of 
section 512(b)(3), since it represents more than an incidental portion 
of the total rent.

    (5) Rendering of services. For purposes of this paragraph, payments 
for the use or occupancy of rooms and other space where services are 
also rendered to the occupant, such as for the use or occupancy of rooms 
or other quarters in hotels, boarding houses, or apartment houses 
furnishing hotel services, or in tourist camps or tourist homes, motor 
courts, or motels, or for the use of occupancy of space in parking lots, 
warehouses, or storage garages, does not constitute rent from real 
property. Generally, services are considered rendered to the occupant if 
they are primarily for his convenience and are other than those usually 
or customarily rendered in connection with the rental of rooms or other 
space for occupancy only. The supplying of maid service, for example, 
constitutes such service; whereas the furnishing of heat and light, the 
cleaning of public entrances, exists, stairways, and lobbies, the 
collection of trash, etc., are not considered as services rendered to 
the occupant. Payments for the use or occupancy of entire private 
residences or living quarters in duplex or multiple housing units, of 
offices in any office building, etc., are generally treated as rent from 
real property.
    (d)(1) Gains and losses from the sale, etc. of property. There shall 
also be excluded from the computation of unrelated business taxable 
income gains or losses from the sale, exchange, or other disposition of 
property other than (i) stock in trade or other property of a kind which 
would properly be included in the inventory of the organization if on 
hand at the close of the taxable year, or (ii) property held primarily 
for sale to customers in the ordinary course of the trade or business. 
This exclusion does not apply with respect to the cutting of timber 
which is considered, upon the application of section 631(a), as a sale 
or exchange of such timber. In addition, for taxable years beginning 
after December 31, 1969, this exclusion does not apply to the gain 
derived from the sale or other disposition of debt-financed property (as 
defined in section 514(b)). Otherwise, the exclusion under section 
512(b)(5) applies with respect to gains and losses from involuntary 
conversions, casualties, etc.
    (2) There shall be excluded from the computation of unrelated 
business taxable income any gain from the lapse or termination after 
December 31, 1975, of options to buy or sell securities (as that term is 
defined in section 1236(c)). An option is considered terminated when the 
organization's obligation under the option ceases by any means other 
than by reason of the exercise or lapse of such option. If the exclusion 
is otherwise available it will apply whether or not the organization 
owns the securities upon which the option is written, that is, whether 
or not the option is covered. However, income from the lapse or 
termination of an option is excludable only if the option is written in 
connection with the organization's

[[Page 182]]

investment activities. Thus, for example, if the securities upon which 
the options are written are held by the organization as inventory or for 
sale to customers in the ordinary course of a trade or business, the 
income from the lapse or termination will not be excludable under the 
provisions of this paragraph. Similarly, if an organization is engaged 
in the trade or business of writing options (whether or not such options 
are covered) the exclusion will not be available.
    (e) Net operating losses. (1) The net operating loss deduction 
provided in section 172 shall be allowed in computing unrelated business 
taxable income. However, the net operating loss carryback or carryover 
(from a taxable year for which the taxpayer is subject to the provisions 
of section 511) shall be determined under section 172 without taking 
into account any amount of income or deduction which is not included 
under section 511 in computing unrelated business taxable income. For 
example, a loss attributable to an unrelated trade or business shall not 
be diminished by reason of the receipt of dividend income.
    (2) For the purpose of computing the net operating loss deduction 
provided by section 172, any prior taxable year for which an 
organization was not subject to the provisions of section 511, or a 
corresponding provision of prior law, shall not be taken into account. 
Thus, if the organization was not subject to the provisions of section 
511 or supplement U of the Internal Revenue Code of 1939 for a preceding 
taxable year, the net operating loss is not a carryback to such 
preceding taxable year, and the net operating loss carryover to 
succeeding taxable years is not reduced by the taxable income for such 
preceding taxable year.
    (3) A net operating loss carryback or carryover shall be allowed 
only from a taxable year for which the taxpayer is subject to the 
provisions of section 511, or a corresponding provision of prior law.
    (4) In determining the span of years for which a net operating loss 
may be carried for purposes of section 172, taxable years in which an 
organization was not subject to the provisions of section 511 or a 
corresponding provision of prior law shall be taken into account. Thus, 
for example, if an organization is subject to the provisions of section 
511 for the taxable year 1955 and has a net operating loss for that 
year, the last taxable year to which any part thereof may be carried 
over is the year 1960 regardless of whether the organization is subject 
to the provisions of section 511 in any of the intervening taxable 
years.
    (f) Research. (1) Income derived from research for the United States 
or any of its agencies or instrumentalities or a State or political 
subdivision thereof, and all deductions directly connected with such 
income, shall be excluded in computing unrelated business taxable 
income.
    (2) In the case of a college, university, or hospital, all income 
derived from research performed for any person and all deductions 
directly connected with such income, shall be excluded in computing 
unrelated business taxable income.
    (3) In the case of an organization operated primarily for the 
purpose of carrying on fundamental research (as distinguished from 
applied research) the results of which are freely available to the 
general public, all income derived from research performed for any 
person and all deductions directly connected with such income shall be 
excluded in computing unrelated business taxable income.
    (4) For the purpose of Sec. Sec. 1.512(a)-1, 1.512(a)-2, and this 
section, the term research does not include activities of a type 
ordinarily carried on as an incident to commercial or industrial 
operations, for example, the ordinary testing or inspection of materials 
or products or the designing or construction of equipment, buildings, 
etc. The term fundamental research does not include research carried on 
for the primary purpose of commercial or industrial application.
    (g) Charitable, etc., contributions. (1) In computing the unrelated 
business taxable income of an organization described in section 
511(a)(2) the deduction from gross income allowed by section 170 
(relating to charitable contributions and gifts) shall be allowed, 
whether or not the contribution is directly connected with the carrying 
on

[[Page 183]]

of the trade or business. Section 512(b)(10) provides that this 
deduction shall not exceed 5 percent of the organization's unrelated 
business taxable income computed without regard to that deduction. The 
provisions of section 170(b)(2) are not applicable to contributions by 
the organizations described in section 511(a)(2).
    (2) In computing the unrelated business taxable income of a trust 
described in section 511(b)(2), the deduction allowed by section 170 
(relating to charitable contributions and gifts) shall be allowed 
whether or not the contribution is directly connected with the carrying 
on of the trade or business. The deduction is limited as provided in 
section 170(b)(1) (A) and (B), except that the amounts so allowed are 
determined on the basis of unrelated business taxable income computed 
without regard to this deduction (rather than on the basis of adjusted 
gross income). For purposes of this deduction, a distribution by a trust 
described in section 511(b)(2) made pursuant to the trust instrument to 
a beneficiary described in section 170 shall be treated in the same 
manner as gifts or contributions.
    (3) The contribution, whether made by a trust or other exempt 
organization, must be paid to another organization to be allowable. For 
example, a university described in section 501(c)(3) which is exempt 
from tax and which operates an unrelated business, shall be allowed a 
deduction, not in excess of 5 percent of its unrelated business taxable 
income, for gifts or contributions to another university described in 
section 501(c)(3) for educational work but shall not be allowed any 
deduction for amounts expended in administering its own educational 
program.
    (h) Specific deduction--(1) In general. In computing unrelated 
business taxable income a specific deduction from gross income of $1,000 
is allowed. However, for taxable years beginning after December 31, 
1969, such specific deduction is not allowed in computing the net 
operating loss under section 172 and paragraph (6) of section 512(b).
    (2) Special rule for a diocese, province of a religious order, or a 
convention or association of churches. (i) In the case of a diocese, 
province of a religious order, or a convention or association of 
churches, there shall be allowed with respect to each parish, individual 
church, district, or other local unit a specific deduction equal to the 
lower of $1,000 or the gross income derived from an unrelated trade or 
business regularly conducted by such local unit. However, a diocese, 
province of a religious order, or a convention or association of 
churches shall not be entitled to a specific deduction for a local unit 
which, for a taxable year, files a separate return. In the case of a 
local unit which, for a taxable year, files a separate return, such 
local unit may claim a specific deduction equal to the lower of $1,000 
or the gross income derived from any unrelated trade or business which 
it regularly conducts.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. X is an association of churches on the calendar year basis. 
X is divided into local units A, B, C, and D. During 1973, A, B, C, and 
D derive gross income of, respectively, $1,200, $800, $1,500, and $700 
from unrelated businesses which they regularly conduct. Furthermore, for 
such taxable year, D files a separate return. X may claim a specific 
deduction of $1,000 with respect to A, $800 with respect to B, and 
$1,000 with respect to C. X may not claim a specific deduction with 
respect to D. D, however, may claim a specific deduction of $700 on its 
return.

    (i) Transitional period for churches. (1)(i) In the case of an 
unrelated trade or business (as defined in section 513) carried on 
before May 27, 1969, by a church or convention or association of 
churches (as defined in Sec. 1.511-2(a)(3)(ii)), or by the predecessor 
of a church or convention or association of churches which predecessor 
was itself a church or convention or association of churches, all gross 
income derived from such unrelated trade or business and all deductions 
directly connected with the carrying on of such unrelated trade or 
business shall be excluded from the determination of unrelated business 
taxable income under section 512(a) for all taxable years beginning 
before January 1, 1976. Notwithstanding the preceding sentence, in the 
case of income from debt-financed property (and the deductions 
attributable thereto), as defined in section

[[Page 184]]

514, of a church or convention or association of churches or by the 
predecessor of a church or convention or association of churches, the 
provisions of paragraphs (a) through (e) of section 514 and paragraph 
(4) of section 512(b) shall apply for taxable years beginning after 
December 31, 1969.
    (ii) The provisions of subdivision (i) may be illustrated by the 
following example:

    Example. X, a church as defined in Sec. 1.511-2(a)(3)(ii), realizes 
gross income from an unrelated business (as defined in section 513) of 
$100,000 for calendar year 1972. X's predecessor church, Y, began 
conducting such unrelated business in January 1, 1968. Of the $100,000 
realized for calendar year 1972, $40,000 is attributable to debt-
financed property (as defined in section 514). Since the unrelated 
business was conducted by Y prior to May 27, 1969, and since X's taxable 
year begins before January 1, 1976, that amount of the income realized 
from such business (and all deductions directly connected therewith) 
which is not attributable to debt-financed property shall be excluded 
from the determination of unrelated business taxable income under 
section 512(a). Therefore, of the $100,000 realized, $60,000 ($100,000 
less $40,000 attributable to debt-financed property), and all deductions 
directly connected therewith shall be excluded from the determination of 
such unrelated business taxable income for purposes of imposition of the 
tax under section 511(a). The remaining $40,000 and the deductions 
attributable thereto shall be subject to the provisions of paragraphs 
(a) through (e) of section 514 and paragraph (4) of section 512(b).

    (2) This paragraph shall not apply in the case of income from 
property, or deductions directly connected with such income, if title to 
the property is held by a corporation described in section 501(c)(2) for 
a church or convention or association of churches. Thus, if such income 
is derived from an unrelated trade or business, the corporation shall be 
liable for tax imposed by section 511(a) on such income.
    (j) Special rule for certain unrelated trades or businesses carried 
on by a religious order or by an educational institution maintained by 
such order. (1) Except as provided in subparagraph (2) of this 
paragraph, gross income realized by a religious order (or an educational 
organization described in section 170(b)(1)(A)(ii) maintained by such 
order) from an unrelated trade or business, together with all deductions 
directly connected therewith, shall be excluded from the determination 
of unrelated business taxable income under section 512(a), if:
    (i) The trade or business has been operated by such order or by such 
institution since before May 27, 1959,
    (ii) The trade or business consists of providing services under a 
license issued by a Federal regulatory agency,
    (iii) More than 90 percent of the net income from the business is, 
for each taxable year for which gross income from such business is so 
excluded by reason of section 512(b)(15) and this paragraph, devoted to 
religious, charitable, or educational purposes, and
    (iv) It is established to the satisfaction of an officer no lower 
than the Regional Commissioner that the rates or other charges for such 
services are fully competitive with rates or other charges charged for 
such services by persons not exempt from taxation. Rates or other 
charges for such services shall be considered as fully competitive with 
rates or other charges charged for such services by persons not exempt 
from taxation if the rates charged by such unrelated trade or business 
are neither materially higher nor materially lower than the rates 
charged by similar businesses operating in the same general area.
    (2) The provisions of this paragraph shall not apply with respect to 
income from debt-financed property (as defined in section 514) and the 
deductions attributable thereto. For taxable years beginning after 
December 31, 1969, such income and deductions are subject to the 
provisions of paragraphs (a) through (e) of section 514 and paragraph 
(4) of section 512(b).
    (k) Income and deductions from debt-financed property. For taxable 
years beginning after December 31, 1969, in the case of debt-financed 
property (as defined in section 514(b)), there shall be included in the 
unrelated business taxable income of an exempt organization, as an item 
of gross income derived from an unrelated trade or business, the amount 
of unrelated debt-financed income determined under section 514(a)(1) and 
Sec. 1.514(a)-1(a), and there shall be allowed, as a deduction with

[[Page 185]]

respect to such income, the amount determined under section 514(a)(2) 
and Sec. 1.514(a)-1(b).
    (l) Interest, annuities, royalties, and rents from controlled 
organizations--(1) In general. For taxable years beginning after 
December 31, 1969, if an exempt organization (hereinafter referred to as 
the controlling organization) has control (as defined in subparagraph 
(4) of this paragraph) of another organization (hereinafter referred to 
as the controlled organization), the controlling organization shall 
include as an item of gross income in computing its unrelated business 
taxable income, the amount of interest, annuities, royalties, and rents 
derived from the controlled organization determined under subparagraph 
(2) or (3) of this paragraph. The preceding sentence shall apply whether 
or not the activity conducted by the controlling organization to derive 
such amounts represents a trade or business or is regularly carried on. 
Thus, amounts received by a controlling organization from the rental of 
its real property to a controlled organization may be included in the 
unrelated business taxable income of the controlling organization, even 
though the rental of such property is not an activity regularly carried 
on by the controlling organization.
    (2) Exempt controlled organization--(i) In general. If the 
controlled organization is exempt from taxation under section 501(a), 
the amount referred to in subparagraph (1) of this paragraph is an 
amount which bears the same ratio to the interest, annuities, royalties, 
and rents received by the controlling organization from the controlled 
organization as the unrelated business taxable income of the controlled 
organization bears to whichever of the following amounts is the greater:
    (a) The taxable income of the controlled organization, computed as 
though the controlled organization were not exempt from taxation under 
section 501(a), or
    (b) The unrelated business taxable income of the controlled 
organization


both determined without regard to any amounts paid directly or 
indirectly to the controlling organization. The controlling organization 
shall be allowed all deductions directly connected with amounts included 
in gross income under the preceding sentence.
    (ii) Examples. This subparagraph may be illustrated by the following 
examples:

    Example 1. A, an exempt scientific organization described in section 
501(c)(3), owns all the stock of B, another exempt scientific 
organization described in section 501(c)(3). During 1971, A rents space 
for a laboratory to B for $15,000 a year. A's total deductions for 1971 
with respect to the leased property are $3,000: $1,000 for maintenance 
and $2,000 for depreciation. If B were not an exempt organization, its 
total taxable income would be $300,000, disregarding rent paid to A. B's 
unrelated business taxable income, disregarding rent paid to A, is 
$100,000. Under these circumstances, $4,000 of the rent paid by B will 
be included by A as net rental income in determining its unrelated 
business taxable income, computed as follows:

B's unrelated business taxable income (disregarding rent        $100,000
 paid to A)................................................
B's taxable income (computed as though B were not exempt         300,000
 and disregarding rent paid to A)..........................
Ratio ($100,000/$300,000)..................................        \1/3\
Total rent.................................................       15,000
Total deductions...........................................        3,000
Rental income treated as gross income from an unrelated            5,000
 trade or business (\1/3\ of $15,000)......................
Less deductions directly connected with such income (\1/3\         1,000
 of $3,000)................................................
                                                            ------------
Net rental income included by A in computing its unrelated        $4,000
 business taxable income...................................
 

    Example 2. Assume the facts as stated in example 1, except that B's 
taxable income is $90,000 (computed as though B were not an exempt 
organization, and disregarding rents paid to A). B's unrelated business 
taxable income ($100,000) is therefore greater than its taxable income 
($90,000). Thus, the ratio used to determine the portion of rent 
received by A which is to be taken into account is one since both the 
numerator and denominator of such ratio is B's unrelated business 
taxable income. Consequently, all the rent received by A from B 
($15,000), and all the deductions directly connected therewith ($3,000), 
are included by A in computing its unrelated business taxable income.

    (3) Nonexempt controlled organization--(i) In general. If the 
controlled organization is not exempt from taxation under section 
501(a), the amount referred to in subparagraph (1) of this paragraph is 
an amount which bears the same ratio to the interest, annuities, 
royalties, and rents received by the controlling organization from the 
controlled organization as the excess taxable income (as defined in 
subdivision

[[Page 186]]

(ii) of this subparagraph) of the controlled organization bears to 
whichever of the following amounts is the greater:
    (a) The taxable income of the controlled organization, or
    (b) The excess taxable income of the controlled organization


both determined without regard to any amount paid directly or indirectly 
to the controlling organization. The controlling organization shall be 
allowed all deductions which are directly connected with amounts 
included in gross income under the preceding sentence.
    (ii) Excess taxable income. For purposes of this paragraph, the term 
excess taxable income means the excess of the controlled organization's 
taxable income over the amount of such taxable income which, if derived 
directly by the controlling organization, would not be unrelated 
business taxable income.
    (iii) Examples. This subparagraph may be illustrated by the 
following examples:

    Example 1. A, an exempt university described in section 501(c)(3), 
owns all the stock of M, a nonexempt organization. During 1971, M leases 
a factory and a dormitory from A for a total annual rent of $100,000. 
During the taxable year, M has $500,000 of taxable income, disregarding 
the rent paid to A: $150,000 from a dormitory for students of A 
university, and $350,000 from the operation of a factory which is a 
business unrelated to A's exempt purpose. A's deductions for 1971 with 
respect to the leased property are $4,000 for the dormitory and $16,000 
for the factory. Under these circumstances, $56,000 of the rent paid by 
M will be included by A as net rental income in determining its 
unrelated business taxable income, computed as follows:

M's taxable income (disregarding rent paid to A)...........     $500,000
Less taxable income from dormitory.........................      150,000
                                                            ------------
Excess taxable income......................................     $350,000
                                                            ============
Ratio ($350,000/$500,000)..................................       \7/10\
Total rent paid to A.......................................     $100,000
Total deductions ($4,000+$16,000)..........................       20,000
Rental income treated as gross income from an unrelated           70,000
 trade or business (\7/10\ of $100,000)....................
Less deductions directly connected with such income (\7/10\       14,000
 of $20,000)...............................................
                                                            ------------
Net rental income included by A in computing its unrelated       $56,000
 business taxable income...................................
 

    Example 2. Assume the facts as stated in example 1, except that M's 
taxable income (disregarding rent paid to A) is $300,000, consisting of 
$350,000 from the operation of the factory and a $50,000 loss from the 
operation of the dormitory. Thus, M's excess taxable income is also 
$300,000, since none of M's taxable income would be excluded from the 
computation of A's unrelated business taxable income if received 
directly by A. The ratio of M's excess taxable income to its taxable 
income is therefore one ($300,000/$300,000). Thus, all the rent received 
by A from M ($100,000), and all the deductions directly connected 
therewith ($20,000), are included in the computation of A's unrelated 
business taxable income.

    (4) Control--(i) In general. For purposes of this paragraph--
    (a) Stock corporation. In the case of an organization which is a 
stock corporation, the term control means ownership by an exempt 
organization of stock possessing at least 80 percent of the total 
combined voting power of all classes of stock entitled to vote and at 
least 80 percent of the total number of shares of all other classes of 
stock of such corporation.
    (b) Nonstock organization. In the case of a nonstock organization, 
the term control means that at least 80 percent of the directors or 
trustees of such organization are either representatives of or directly 
or indirectly controlled by an exempt organization. A trustee or 
director is a representative of an exempt organization if he is a 
trustee, director, agent, or employee of such exempt organization. A 
trustee or director is controlled by an exempt organization if such 
organization has the power to remove such trustee or director and 
designate a new trustee or director.
    (ii) Gain or loss of control. If control of an organization (as 
defined in subdivision (i) of this subparagraph) is acquired or 
relinquished during the taxable year, only the interest, annuities, 
royalties, and rents paid or accrued to the controlling organization in 
accordance with its method of accounting for that portion of the taxable 
year it has control shall be subject to the tax on unrelated business 
income.
    (5) Amounts taxable under other provisions of the Code--(i) In 
general. Except as provided in subdivision (ii) of this subparagraph, 
section 512(b)(13) and this paragraph do not apply to amounts which are 
included in the

[[Page 187]]

computation of unrelated business taxable income by operation of any 
other provision of the Code. However, amounts which are not included in 
unrelated business taxable income by operation of section 512(a)(1), or 
which are excluded by operation of section 512(b) (1), (2), or (3), may 
be included in unrelated business taxable income by operation of section 
512(b)(13) and this paragraph.
    (ii) Debt-financed property. Rents deprived from the lease of debt-
financed property by a controlling organization to a controlled 
organization are subject to the rules contained in section 512(b)(13) 
and this paragraph. Thus, if a controlling organization leases debt-
financed property to a controlled organization, the amount of rents 
includible in the controlling organization's unrelated business taxable 
income shall first be determined under section 512(b)(13) and this 
paragraph, and only the portion of such rents not taken into account by 
operation of section 512(b)(13) are taken into account by operation of 
section 514. See example 3 of Sec. 1.514(b)-1(b)(3).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6939, 32 FR 
17661, Dec. 12, 1967; T.D. 7177, 37 FR 7089, Apr. 8, 1972; T.D. 7183, 37 
FR 7885, Apr. 21, 1972; T.D. 7261, 38 FR 5466, Mar. 1, 1973; 38 FR 6387, 
Mar. 9, 1973; T.D. 7632, 44 FR 42681, July 20, 1979; T.D. 7767, 46 FR 
11265, Feb. 6, 1981; T.D. 8423, 57 FR 33443, July 29, 1992; 57 FR 42490, 
Sept. 15, 1992]



Sec. 1.512(c)-1  Special rules applicable to partnerships; in general.

    In the event an organization to which section 511 applies is a 
member of a partnership regularly engaged in a trade or business which 
is an unrelated trade or business with respect to such organization, the 
organization shall include in computing its unrelated business taxable 
income so much of its share (whether or not distributed) of the 
partnership gross income as is derived from that unrelated business and 
its share of the deductions attributable thereto. For this purpose, both 
the gross income and the deductions shall be computed with the necessary 
adjustments for the exceptions, additions, and limitations referred to 
in section 512(b) and in Sec. 1.512(b)-1. For example, if an exempt 
educational institution is a partner in a partnership which operates a 
factory and if such partnership also holds stock in a corporation, the 
exempt organization shall include in computing its unrelated business 
taxable income its share of the gross income from the operation of the 
factory, but not its share of any dividends received by the partnership 
from the corporation. If the taxable year of the organization differs 
from that of the partnership, the amounts included or deducted in 
computing unrelated business taxable income shall be based upon the 
income and deductions of the partnership for each taxable year of the 
partnership ending within or with the taxable year of the organization.



Sec. 1.513-1  Definition of unrelated trade or business.

    (a) In general. As used in section 512 the term unrelated business 
taxable income means the gross income derived by an organization from 
any unrelated trade or business regularly carried on by it, less the 
deductions and subject to the modifications provided in section 512. 
Section 513 specifies with certain exceptions that the phrase unrelated 
trade or business means, in the case of an organization subject to the 
tax imposed by section 511, any trade or business the conduct of which 
is not substantially related (aside from the need of such organization 
for income or funds or the use it makes of the profits derived) to the 
exercise or performance by such organization of its charitable, 
educational, or other purpose or function constituting the basis for its 
exemption under section 501 (or, in the case of an organization 
described in section 511(a)(2)(B), to the exercise or performance of any 
purpose or function described in section 501(c)(3)). (For certain 
exceptions from this definition, see paragraph (e) of this section. For 
a special definition of unrelated trade or business applicable to 
certain trusts, see section 513(b).) Therefore, unless one of the 
specific exceptions of section 512 or 513 is applicable, gross income of 
an exempt organization subject to the tax imposed by section 511 is 
includible in the computation of unrelated business taxable income if: 
(1) It is income from trade or business; (2) such trade or business is 
regularly carried on by the organization; and (3) the conduct of

[[Page 188]]

such trade or business is not substantially related (other than through 
the production of funds) to the organization's performance of its exempt 
functions.
    (b) Trade or business. The primary objective of adoption of the 
unrelated business income tax was to eliminate a source of unfair 
competition by placing the unrelated business activities of certain 
exempt organizations upon the same tax basis as the nonexempt business 
endeavors with which they compete. On the other hand, where an activity 
does not possess the characteristics of a trade or business within the 
meaning of section 162, such as when an organization sends out low-cost 
articles incidental to the solicitation of charitable contributions, the 
unrelated business income tax does not apply since the organization is 
not in competition with taxable organizations. However, in general, any 
activity of a section 511 organization which is carried on for the 
production of income and which otherwise possesses the characteristics 
required to constitute trade or business within the meaning of section 
162--and which, in addition, is notsubstantially related to the 
performance of exempt functions--presents sufficient likelihood of 
unfair competition to be within the policy of the tax. Accordingly, for 
purposes of section 513 the term trade or business has the same meaning 
it has in section 162, and generally includes any activity carried on 
for the production of income from the sale of goods or performance of 
services. Thus, the term trade or business in section 513 is not limited 
to integrated aggregates of assets, activities and good will which 
comprise businesses for the purposes of certain other provisions of the 
Internal Revenue Code. Activities of producing or distributing goods or 
performing services from which a particular amount of gross income is 
derived do not lose identity as trade or business merely because they 
are carried on within a larger aggregate of similar activities or within 
a larger complex of other endeavors which may, or may not, be related to 
the exempt purposes of the organization. Thus, for example, the regular 
sale of pharmaceutical supplies to the general public by a hospital 
pharmacydoes not lose identity as trade or business merely because the 
pharmacy also furnishes supplies to the hospital and patients of the 
hospital in accordance with its exempt purposes or in compliance with 
the terms of section 513(a)(2). Similarly, activities of soliciting, 
selling, and publishing commercial advertising do not lose identity as a 
trade or business even though the advertising is published in an exempt 
organization periodical which contains editorial matter related to the 
exempt purposes of the organization. However, where an activity carried 
on for the production of income constitutes an unrelated trade or 
business, no part of such trade or business shall be excluded from such 
classification merely because it does not result in profit.
    (c) Regularly carried on--(1) General principles. In determining 
whether trade or business from which a particular amount of gross income 
derives is regularly carried on, within the meaning of section 512, 
regard must be had to the frequency and continuity with which the 
activities productive of the income are conducted and the manner in 
which they are pursued. This requirement must be applied in light of the 
purpose of the unrelated business income tax to place exempt 
organization business activities upon the same tax basis as the 
nonexempt business endeavors with which they compete. Hence, for 
example, specific business activities of an exempt organization will 
ordinarily be deemed to be regularly carried on if they manifest a 
frequency and continuity, and are pursued in a manner, generally similar 
to comparable commercial activities of nonexempt organizations.
    (2) Application of principles in certain cases--(i) Normal time span 
of activities. Where income producing activities are of a kind normally 
conducted by nonexempt commercial organizations on a year-round basis, 
the conduct of such activities by an exempt organization over a period 
of only a few weeks does not constitute the regular carrying on of trade 
or business. For example, the operation of a sandwich stand by a 
hospital auxiliary for only 2 weeks at a state fair would not be the 
regular conduct of trade or business. However, the

[[Page 189]]

conduct of year-round business activities for one day each week would 
constitute the regular carrying on of trade or business. Thus, the 
operation of a commercial parking lot on Saturday of each week would be 
the regular conduct of trade or business. Where income producing 
activities are of a kind normally undertaken by nonexempt commercial 
organizations only on a seasonal basis, the conduct of such activities 
by an exempt organization during a significant portion of the season 
ordinarilyconstitutes the regular conduct of trade or business. For 
example, the operation of a track for horse racing for several weeks of 
a year would be considered the regular conduct of trade or business 
because it is usual to carry on such trade or business only during a 
particular season.
    (ii) Intermittent activities; in general. In determining whether or 
not intermittently conducted activities are regularly carried on, the 
manner of conduct of the activities must be compared with the manner in 
which commercial activities are normally pursued by nonexempt 
organizations. In general, exempt organization business activities which 
are engaged in only discontinuously or periodically will not be 
considered regularly carried on if they are conducted without the 
competitive and promotional efforts typical of commercial endeavors. For 
example, the publication of advertising in programs for sports events or 
music or drama performances will not ordinarily be deemed to be the 
regular carrying on of business. Similarly, where an organization sells 
certain types of goods or services to a particular class of persons in 
pursuance of its exempt functions or primarily for the convenience of 
such persons within the meaning of section 513(a)(2) (as, for example, 
the sale of books by a college bookstore to students or the sale of 
pharmaceutical supplies by a hospital pharmacy to patients of the 
hospital), casual sales in the course of such activity which do not 
qualify as related to the exempt function involved or as described in 
section 513(a)(2) will not be treated as regular. On the other hand, 
where the nonqualifyingsales are not merely casual, but are 
systematically and consistently promoted and carried on by the 
organization, they meet the section 512 requirement of regularity.
    (iii) Intermittent activities; special rule in certain cases of 
infrequent conduct. Certain intermittent income producing activities 
occur so infrequently that neither their recurrence nor the manner of 
their conduct will cause them to be regarded as trade or business 
regularly carried on. For example, income producing or fund raising 
activities lasting only a short period of time will not ordinarily be 
treated as regularly carried on if they recur only occasionally or 
sporadically. Furthermore, such activities will not be regarded as 
regularly carried on merely because they are conducted on an annually 
recurrent basis. Accordingly, income derived from the conduct of an 
annual dance or similar fund raising event for charity would not be 
income from trade or business regularly carried on.
    (d) Substantially related--(1) In general. Gross income derives from 
unrelated trade or business, within the meaning of section 513(a), if 
the conduct of the trade or business which produces the income is not 
substantially related (other than through the production of funds) to 
the purposes for which exemption is granted. The presence of this 
requirement necessitates an examination of the relationship between the 
business activities which generate the particular income in question--
the activities, that is, of producing or distributing the goods or 
performing the services involved--and the accomplishment of the 
organization's exempt purposes.
    (2) Type of relationship required. Trade or business is related to 
exempt purposes, in the relevant sense, only where the conduct of the 
business activities has causal relationship to the achievement of exempt 
purposes (other than through the production of income); and it is 
substantially related, for purposes of section 513, only if the causal 
relationship is a substantial one. Thus, for the conduct of trade or 
business from which a particular amount of gross income is derived to be 
substantially related to purposes for which exemption is granted, the 
production or distribution of the goods or the performance of the 
services from which the gross income is derived must contribute 
importantly to the accomplishment of those

[[Page 190]]

purposes. Where the production or distribution of the goods or the 
performance of the services does not contribute importantly to the 
accomplishment of the exempt purposes of an organization, the income 
from the sale of the goods or the performance of the services does not 
derive from the conduct of related trade or business. Whether activities 
productive of gross income contribute importantly to the accomplishment 
of any purpose for which an organization is granted exemption depends in 
each case upon the facts and circumstances involved.
    (3) Size and extent of activities. In determining whether activities 
contribute importantly to the accomplishment of an exempt purpose, the 
size and extent of the activities involved must be considered in 
relation to the nature and extent of the exempt function which they 
purport to serve. Thus, where income is realized by an exempt 
organization from activities which are in part related to the 
performance of its exempt functions, but which are conducted on a larger 
scale than is reasonably necessary for performance of such functions, 
the gross income attributable to that portion of the activities in 
excess of the needs of exempt functions constitutes gross income from 
the conduct of unrelated trade or business. Such income is not derived 
from the production or distribution of goods or the performance of 
services which contribute importantly to the accomplishment of any 
exempt purpose of the organization.
    (4) Application of principles--(i) Income from performance of exempt 
functions. Gross income derived from charges for the performance of 
exempt functions does not constitute gross income from the conduct of 
unrelated trade or business. The following examples illustrate the 
application of this principle:

    Example 1. M, an organization described in section 501(c)(3), 
operates a school for training children in the performing arts, such as 
acting, singing, and dancing. It presents performances by its students 
and derives gross income from admission charges for the performances. 
The students' participation in performances before audiences is an 
essential part of their training. Since the income realized from the 
performances derives from activities which contribute importantly to the 
accomplishment of M's exempt purposes, it does not constitute gross 
income from unrelated trade or business. (For specific exclusion 
applicable in certain cases of contributed services, see section 
513(a)(1) and paragraph (e)(1) of this section.)
    Example 2. N is a trade union qualified for exemption under section 
501(c)(5). To improve the trade skills of its members, N conducts 
refresher training courses and supplies handbooks and technical manuals. 
N receives payments from its members for these services and materials. 
However, the development and improvement of the skills of its members is 
one of the purposes for which exemption is granted N; and the activities 
described contribute importantly to that purpose. Therefore, the income 
derived from these activities does not constitute gross income from 
unrelated trade or business.
    Example 3. O is an industry trade association qualified for 
exemption under section 501(c)(6). It presents a trade show in which 
members of its industry join in an exhibition of industry products. O 
derives income from charges made to exhibitors for exhibit space and 
admission fees charged patrons or viewers of the show. The show is not a 
sales facility for individual exhibitors; its purpose is the promotion 
and stimulation of interest in, and demand for, the industry's products 
in general, and it is conducted in a manner reasonably calculated to 
achieve that purpose. The stimulation of demand for the industry's 
products in general is one of the purposes for which exemption is 
granted O. Consequently, the activities productive of O's gross income 
from the show--that is, the promotion, organization and conduct of the 
exhibition--contribute importantly to the achievement of an exempt 
purpose, and the income does not constitute gross income from unrelated 
trade or business. See also section 513(d) and regulations thereunder 
regarding sales activity.

    (ii) Disposition of product of exempt functions. Ordinarily, gross 
income from the sale of products which result from the performance of 
exempt functions does not constitute gross income from the conduct of 
unrelated trade or business if the product is sold in substantially the 
same state it is in on completion of the exempt functions. Thus, in the 
case of an organization described in section 501(c)(3) and engaged in a 
program of rehabilitation of handicapped persons, income from sale of 
articles made by such persons as a part of their rehabilitation training 
would not be gross income from conduct of unrelated trade or business. 
The income in

[[Page 191]]

such case would be from sale of products, the production of which 
contributed importantly to the accomplishment of purposes for which 
exemption is granted the organization--namely, rehabilitation of the 
handicapped. On the other hand, if a product resulting from an exempt 
function is utilized or exploitedin further business endeavor beyond 
that reasonably appropriate or necessary for disposition in the state it 
is in upon completion of exempt functions, the gross income derived 
therefrom would be from conduct of unrelated trade or business. Thus, in 
the case of an experimental dairy herd maintained for scientific 
purposes by a research organization described in section 501(c)(3), 
income from sale of milk and cream produced in the ordinary course of 
operation of the project would not be gross income from conduct of 
unrelated trade or business. On the other hand, if the organization were 
to utilize the milk and cream in the further manufacture of food items 
such as ice cream, pastries, etc., the gross income from the sale of 
such products would be from the conduct of unrelated trade or business 
unless the manufacturing activities themselves contribute importantly to 
the accomplishment of an exempt purpose of the organization.
    (iii) Dual use of assets or facilities. In certain cases, an asset 
or facility necessary to the conduct of exempt functions may also be 
employed in a commercial endeavor. In such cases, the mere fact of the 
use of the asset or facility in exempt functions does not, by itself, 
make the income from the commercial endeavor gross income from related 
trade or business. The test, instead, is whether the activities 
productive of the income in question contribute importantly to the 
accomplishment of exempt purposes. Assume, for example, that a museum 
exempt under section 501(c)(3) has a theater auditorium which is 
specially designed and equipped for showing of educational films in 
connection with its program of public education in the arts and 
sciences. The theater is a principal feature of the museum and is in 
continuous operation during the hours the museum is open to the public. 
If the organization were to operate the theater as an ordinary motion 
picture theater for public entertainment during the evening hours when 
the museum was closed, gross income from such operation would be gross 
income from conduct of unrelated trade or business.
    (iv) Exploitation of exempt functions. In certain cases, activities 
carried on by an organization in the performance of exempt functions may 
generate good will or other intangibles which are capable of being 
exploited in commercial endeavors. Where an organization exploits such 
an intangible in commercial activities, the mere fact that the resultant 
income depends in part upon an exempt function of the organization does 
not make it gross income from related trade or business. In such cases, 
unless the commercial activities themselves contribute importantly to 
the accomplishment of an exempt purpose, the income which they produce 
is gross income from the conduct of unrelated trade or business. The 
application of this subdivision is illustrated in the following 
examples:

    Example 1. U, an exempt scientific organization, enjoys an excellent 
reputation in the field of biological research. It exploits this 
reputation regularly by selling endorsements of various items of 
laboratory equipment to manufacturers. The endorsing of laboratory 
equipment does not contribute importantly to the accomplishment of any 
purpose for which exemption is granted U. Accordingly, the income 
derived from the sale of endorsements is gross income from unrelated 
trade or business.
    Example 2. V, an exempt university, has a regular faculty and a 
regularly enrolled student body. During the school year, V sponsors the 
appearance of professional theater companies and symphony orchestras 
which present drama and musical performances for the students and 
faculty members. Members of the general public are also admitted. V 
advertises these performances and supervises advance ticket sales at 
various places, including such university facilities as the cafeteria 
and the university bookstore. V derives gross income from the conduct of 
the performances. However, while the presentation of the performances 
makes use of an intangible generated by V's exempt educational 
functions--the presence of the student body and faculty--the 
presentation of such drama and music events contributes importantly to 
the overall educational and cultural function of the university. 
Therefore, the income which V receives does not constitute gross income 
from the conduct of unrelated trade or business.

[[Page 192]]

    Example 3. W is an exempt business league with a large membership. 
Under an arrangement with an advertising agency, W regularly mails 
brochures, pamphlets and other commercial advertising materials to its 
members, for which service W charges the agency an agreed amount per 
enclosure. The distribution of the advertising materials does not 
contribute importantly to the accomplishment of any purpose for which W 
is granted exemption. Accordingly, the payments made to W by the 
advertising agency constitute gross income from unrelated trade or 
business.
    Example 4. X, an exempt organization for the advancement of public 
interest in classical music, owns a radio station and operates it in a 
manner which contributes importantly to the accomplishment of the 
purposes for which the organization is granted exemption. However, in 
the course of the operation of the station the organization derives 
gross income from the regular sale of advertising time and services to 
commercial advertisers in the manner of an ordinary commercial station. 
Neither the sale of such time nor the performance of such services 
contributes importantly to the accomplishment of any purpose for which 
the organization is granted exemption. Notwithstanding the fact that the 
production of the advertising income depends upon the existence of the 
listening audience resulting from performance of exempt functions, such 
income is gross income from unrelated trade or business.
    Example 5. Y, an exempt university, provides facilities, instruction 
and faculty supervision for a campus newspaper operated by its students. 
In addition to news items and editorial commentary, the newspaper 
publishes paid advertising. The solicitation, sale, and publication of 
the advertising are conducted by students, under the supervision and 
instruction of the university. Although the services rendered to 
advertisers are of a commercial character, the advertising business 
contributes importantly to the university's educational program through 
the training of the students involved. Hence, none of the income derived 
from publication of the newspaper constitutes gross income from 
unrelated trade or business. The same result would follow even though 
the newspaper is published by a separately incorporated section 
501(c)(3) organization, qualified under the university rules for 
recognition of student activities, and even though such organization 
utilizes its own facilities and is independent of faculty supervision, 
but carries out its educational purposes by means of student instruction 
of other students in the editorial and advertising activities and 
student participation in those activities.
    Example 6. Z is an association exempt under section 501(c)(6), 
formed to advance the interests of a particular profession and drawing 
its membership from the members of that profession. Z publishes a 
monthly journal containing articles and other editorial material which 
contribute importantly to the accomplishment of purposes for which 
exemption is granted the organization. Income from the sale of 
subscriptions to members and others in accordance with the 
organization's exempt purposes, therefore, does not constitute gross 
income from unrelated trade or business. In connection with the 
publication of the journal, Z also derives income from the regular sale 
of space and services for general consumer advertising,including 
advertising of such products as soft drinks, automobiles, articles of 
apparel, and home appliances. Neither the publication of such 
advertisements nor the performance of services for such commercial 
advertisers contributes importantly to the accomplishment of any purpose 
for which exemption is granted. Therefore, notwithstanding the fact that 
the production of income from advertising utilizes the circulation 
developed and maintained in performance of exempt functions, such income 
is gross income from unrelated trade or business.
    Example 7. The facts are as described in the preceding example, 
except that the advertising in Z's journal promotes only products which 
are within the general area of professional interest of its members. 
Following a practice common among taxable magazines which publish 
advertising, Z requires its advertising to comply with certain general 
standards of taste, fairness, and accuracy; but within those limits the 
form, content, and manner of presentation of the advertising messages 
are governed by the basic objective of the advertisers to promote the 
sale of the advertised products. While the advertisements contain 
certain information, the informational function of the advertising is 
incidental to the controlling aim of stimulating demand for the 
advertised products and differs in no essential respect from the 
informational function of any commercial advertising. Like taxable 
publishers of advertising, Z accepts advertising only from those who are 
willing to pay its prescribed rates. Although continuing education of 
itsmembers in matters pertaining to their profession is one of the 
purposes for which Z is granted exemption, the publication of 
advertising designed and selected in the manner of ordinary commercial 
advertising is not an educational activity of the kind contemplated by 
the exemption statute; it differs fundamentally from such an activity 
both in its governing objective and in its method. Accordingly, Z's 
publication of advertising does not contribute importantly to the 
accomplishment of its exempt purposes;

[[Page 193]]

and the income which it derives from advertising constitutes gross 
income from unrelated trade or business.

    (e) Exceptions. Section 513(a) specifically states that the term 
unrelated trade or business does not include:
    (1) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation; or
    (2) Any trade or business carried on by an organization described in 
section 501(c)(3) or by a governmental college or university described 
in section 511(a)(2)(B), primarily for the convenience of its members, 
students, patients, officers, or employees; or, any trade or business 
carried on by a local association of employees described in section 
501(c)(4) organized before May 27, 1969, which consists of the selling 
by the organization of items of work-related clothes and equipment and 
items normally sold through vending machines, through food dispensing 
facilities, or by snack bars, for the convenience of its members at 
their usual places of employment; or
    (3) Any trade or business which consists of selling merchandise, 
substantially all of which has been received by the organization as 
gifts or contributions


An example of the operation of the first of the exceptions mentioned 
above would be an exempt orphanage operating a retail store and selling 
to the general public, where substantially all the work in carrying on 
such business is performed for the organization by volunteers without 
compensation. An example of the first part of the second exception, 
relating to an organization described in section 501(c)(3) or a 
governmental college or university described in section 511(a)(2)(B), 
would be a laundry operated by a college for the purpose of laundering 
dormitory linens and the clothing of students. The latter part of the 
second exception, dealing with certain sales by local employee 
associations, will not apply to sales of these items at locations other 
than the usual place of employment of the employees; therefore sales at 
such other locations will continue to be treated as unrelated trade or 
business. The third exception applies to so-called thrift shops operated 
by a tax-exempt organization where those desiring to benefit such 
organization contribute old clothes, books, furniture, et cetera, to be 
sold to the general public with the proceeds going to the exempt 
organization.
    (f) Special rule respecting publishing businesses prior to 1970. For 
a special rule for taxable years beginning before January 1, 1970, with 
respect to publishing businesses carried on by an organization, see 
section 513(c) of the Code prior to its amendment by section 121(c) of 
the Tax Reform Act of 1969 (83 Stat. 542).
    (g) Effective date. This section is applicable with respect to 
taxable years beginning after December 12, 1967. However, if a taxpayer 
wishes to rely on the rules stated in this section for taxable years 
beginning before December 13, 1967, it may do so.

[T.D. 6939, 32 FR 17657, Dec. 12, 1967; 32 FR 17890, Dec. 14, 1967; 32 
FR 17938, Dec. 15, 1967; T.D. 7107, 36 FR 6421, Apr. 3, 1971; T.D. 7392, 
40 FR 58642, Dec. 18, 1975; T.D. 7896, 48 FR 23817, May 27, 1983]



Sec. 1.513-2  Definition of unrelated trade or business applicable to taxable 

years beginning before December 13, 1967.

    (a) In general. (1) As used in section 512(a), the term unrelated 
business taxable income includes only income from an unrelated trade or 
business regularly carried on, and the term trade or business has the 
same meaning as it has in section 162.
    (2) The income of an exempt organization is subject to the tax on 
unrelated business income only if two conditions are present with 
respect to such income. The first condition is that the income must be 
from a trade or business which is regularly carried on by the 
organization. The second condition is that the trade or business must 
not be substantially related (aside from the need of the organization 
for income or funds or the use it makes of the profits derived) to the 
exercise or performance by such organization of its charitable, 
educational, or other purpose or function constituting the basis for its 
exemption under section 501, or in the

[[Page 194]]

case ofan organization described in section 511(a)(2)(B) (governmental 
colleges, etc.) to the exercise or performance of any purpose or 
function described in section 501(c)(3). Whether or not an organization 
is subject to the tax imposed by section 511 shall be determined by the 
application of these tests to the particular circumstances involved in 
each individual case. For certain exceptions from the term unrelated 
trade or business, see paragraph (b) of this section.
    (3) A trade or business is regularly carried on when the activity is 
conducted with sufficient consistency to indicate a continuing purpose 
of the organization to derive some of its income from such activity. An 
activity may be regularly carried on even though its performance is 
infrequent or seasonal.
    (4) Ordinarily, a trade or business is substantially related to the 
activities for which an organization is granted exemption if the 
principal purpose of such trade or business is to further (other than 
through the production of income) the purpose for which the organization 
is granted exemption. In the usual case the nature and size of the trade 
or business must be compared with the nature and extent of the 
activities for which the organization is granted exemption in order to 
determine whether the principal purpose of such trade or business is to 
further (other than through the production of income) the purpose for 
which the organization is granted exemption. For example, the operation 
of a wheat farm is substantially related to the exempt activity of an 
agricultural college if the wheat farm isoperated as a part of the 
educational program of the college, and is not operated on a scale 
disproportionately large when compared with the educational program of 
the college. Similarly, a university radio station or press is 
considered a related trade or business if operated primarily as an 
integral part of the educational program of the university, but is 
considered an unrelated trade or business if operated in substantially 
the same manner as a commercial radio station or publishing house. A 
trade or business not otherwise related does not become substantially 
related to an organization's exempt purpose merely because incidental 
use is made of the trade or business in order to further the exempt 
purpose. For example, the manufacture and sale of a product by an exempt 
college would not become substantially related merely because students 
as part of their educational program perform clerical or bookkeeping 
functions in the business. In some cases, the business may be 
substantially related because it is a necessary part of the exempt 
activity. For example, in the case of an organization described in 
section 501(c)(3) and engaged in the rehabilitation of handicapped 
persons, the business of selling articles made by such persons as a part 
of their rehabilitation training would not be considered an unrelated 
business since such business is a necessary part of the rehabilitation 
program.
    (5) If an organization receives a payment pursuant to a contract or 
agreement under which such organization is to perform research which 
constitutes an unrelated trade or business, the entire amount of such 
payment is income from an unrelated trade or business. See, however, 
section 512(b), (7), (8), and (9), relating to the exclusion from 
unrelated business taxable income of income derived from research for 
the United States, or any State, and of income derived from research 
performed for any person by a college, university, hospital, or 
organization operated primarily for the purpose of carrying on 
fundamental research the results of which are freely available to the 
general public.
    (b) Exceptions. Section 513(a) specifically states that the term 
unrelated trade or business does not include:
    (1) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation; or
    (2) Any trade or business carried on by an organization described in 
section 501(c)(3) or by a governmental college or university described 
in section 511(a)(2)(B), primarily for the convenience of its members, 
students, patients, officers, or employees; or
    (3) Any trade or business which consists of selling merchandise, 
substantially all of which has been received by

[[Page 195]]

the organization as gifts or contributions


An example of the operation of the first of the exceptions mentioned 
above would be an exempt orphanage operating a retail store and selling 
to the general public, where substantially all the work in carrying on 
such business is performed for the organization by volunteers without 
compensation. An example of the second exception would be a laundry 
operated by a college for the purpose of laundering dormitory linens and 
the clothing of students. The third exception applies to so-called 
thrift shops operated by a tax-exempt organization where those desiring 
to benefit such organization contribute old clothes, books, furniture, 
etc., to be sold to the general public with the proceeds going to the 
exempt organization.
    (c) Special rules respecting publishing businesses. For a special 
rule with respect to publishing businesses carried on by an 
organization, see section 513(c) of the Code prior to its amendment by 
section 121(c) of the Tax Reform Act of 1969 (83 Stat. 542).
    (d) Effective date. Except as provided in paragraph (g) of Sec. 
1.513-1, this section is applicable with respect to taxable years 
beginning before December 13, 1967.

(Sec. 513 as amended by sec. 4, Act of July 14, 1960 (P.L. 86-667, 74 
Stat. 536); secs. 121 (b)(4) and (c), Tax Reform Act of 1969 (83 Stat. 
536, 542))

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6525, 26 FR 
190, Jan. 11, 1961; T.D. 6939, 32 FR 17657, Dec. 12, 1967; T.D. 7392, 40 
FR 58643, Dec. 18, 1975; 40 FR 60053, Dec. 31, 1975]



Sec. 1.513-3  Qualified convention and trade show activity.

    (a) Introduction--(1) In general. Section 513(d) and Sec. 1.513-
3(b) provide that convention and trade show activities carried on by a 
qualifying organization in connection with a qualified convention or 
trade show will not be treated as unrelated trade or business. 
Consequently, income from qualified convention and trade show 
activities, derived by a qualifying organization that sponsors the 
qualified convention or trade show, will not be subject to the tax 
imposed by section 511. Section 1.513-3(c) defines qualifying 
organizations and qualified conventions or trade shows. Section 1.513-
3(d) concerns the treatment of income derived from certain activities, 
including rental of exhibition space at a qualified convention or trade 
show where sales activity is permitted, and the treatment of supplier 
exhibits at qualified conventions and trade shows.
    (2) Effective date. This section is effective for taxable years 
beginning after October 4, 1976.
    (b) Qualified activities not unrelated. A convention or trade show 
activity, as defined in section 513(d)(3)(A) and Sec. 1.513-3(c)(4), 
will not be considered unrelated trade or business if it is conducted by 
a qualifying organization described in section 513(d)(3)(C) and Sec. 
1.513-3(c)(1), in conjunction with a qualified convention or trade show, 
as defined in section 513(d)(3)(B) and Sec. 1.513-3(c)(2), sponsored by 
the qualifying organization. Such an activity is a qualified convention 
or trade show activity. A convention or trade show activity which is 
conducted by an organization described in section 501(c) (5) or (6), but 
which otherwise is not so qualified under this section, will be 
considered unrelated trade or business.
    (c) Definitions--(1) Qualifying organization. Under section 
513(d)(3)(C), a qualifying organization is one which:
    (i) Is described in either section 501(c) (5) or (6), and
    (ii) Regularly conducts as one of its substantial exempt purposes a 
qualified convention or trade show.
    (2) Qualified convention or trade show. For purposes of this 
section, the term qualified convention or trade show means a show that 
meets the following requirements:
    (i) It is conducted by a qualifying organization described in 
section 513(d)(3)(C);
    (ii) At least one purpose of the sponsoring organization in 
conducting the show is the education of its members, or the promotion 
and stimulation of interest in, and demand for, the products or services 
of the industry (or segment thereof) of the members of the qualifying 
organization; and
    (iii) The show is designed to achieve that purpose through the 
character of a significant portion of the exhibits or

[[Page 196]]

the character of conferences and seminars held at a convention or 
meeting.
    (3) Show. For purposes of this section, the term show includes an 
international, national, state, regional, or local convention, annual 
meeting or show.
    (4) Convention and trade show activity. For purposes of this 
section, convention and trade show activity means any activity of a kind 
traditionally carried on at shows. It includes, but is not limited to--
    (i) Activities designed to attract to the show members of the 
sponsoring organization, members of an industry in general, and members 
of the public, to view industry products or services and to stimulate 
interest in, and demand for such products or services;
    (ii) Activities designed to educate persons in the industry about 
new products or services or about new rules and regulations affecting 
the industry; and
    (iii) Incidental activities, such as furnishing refreshments, of a 
kind traditionally carried on at such shows.
    (d) Certain activities--(1) Rental of exhibition space. The rental 
of display space to exhibitors (including exhibitors who are suppliers) 
at a qualified trade show or at a qualified convention and trade show 
will not be considered unrelated trade or business even though the 
exhibitors who rent the space are permitted to sell or solicit orders.
    (2) Suppliers defined. For purposes of subparagraph (1), a 
supplier's exhibit is one in which the exhibitor displays goods or 
services that are supplied to, rather than by, the members of the 
qualifying organization in the conduct of such members' own trades or 
businesses.
    (e) Example. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, an organization described in section 501(c)(6), was 
formed to promote the construction industry. Its membership is made up 
of manufacturers of heavy construction machinery many of whom own, rent, 
or lease one or more digital computers produced by various computer 
manufacturers. X is a qualifying organization under section 513(d)(3)(C) 
that regularly holds an annual meeting. At this meeting a national 
industry sales campaign and methods of consumer financing for heavy 
construction machinery are discussed. In addition, new construction 
machinery developed for use in the industry is on display with 
representatives of the various manufacturers present to promote their 
machinery. Both members and nonmembers attend this portion of the 
conference. In addition, manufacturers of computers are present to 
educate X's members. While this aspect of the conference is a supplier 
exhibit (as defined in paragraph (d) of this section), income earned 
from such activity by X will not constitute unrelated business taxable 
income to X because the activity is conducted as part of a qualified 
trade show described in Sec. 1.513-3(c).
    Example 2. Assume the same facts as in Example 1, but the only goods 
or services displayed are those of suppliers, the computer 
manufacturers. Selling and order taking are permitted. No member 
exhibits are maintained. Standing alone, this supplier exhibit (as 
defined in paragraph (d)(2) of this section) would constitute a supplier 
show and not a qualified convention or trade show. In this situation, 
however, the rental of exhibition space to suppliers is not unrelated 
trade or business. It is conducted by a qualifying organization in 
conjunction with a qualified convention or trade show. The show (the 
annual meeting) is a qualified convention or trade show because one of 
its purposes is the promotion and stimulation of interest in, and demand 
for, the products or services of the industry through the character of 
the annual meeting.
    Example 3. Y is an organization described in section 501(c)(6). The 
organization conducts an annual show at which its members exhibit their 
products and services in order to promote public interest in the line of 
business. Potential customers are invited to the show, and sales and 
order taking are permitted. The organization secures the exhibition 
facility, undertakes the planning and direction of the show, and 
maintains exhibits designed to promote the line of business in general. 
The show is a qualified convention or trade show described in paragraph 
(c)(2) of this section. The provision of exhibition space to individual 
members is a qualified trade show activity, and is not unrelated trade 
or business.
    Example 4. Z is an organization described in section 501(c)(6) that 
sponsors an annual show. As the sole activity at the show, suppliers to 
the members of Z exhibit their products and services for the purpose of 
stimulating the sale of their products. Selling and order taking are 
permitted. The show is a supplier show and does not meet the definition 
of a qualified convention show as it does not satisfy any of the three 
alternative bases for qualification. First, the show does not stimulate 
interest in the members' products through the character of

[[Page 197]]

product exhibits as the only products exhibited are those of suppliers 
rather than members. Second, the show does not stimulate interest in 
members' products through conferences or seminars as no such conferences 
are held at the show. Third, the show does not meet the definition of a 
qualified show on the basis of educational activities as the exhibition 
of suppliers' products is designed primarily to stimulate interest in, 
and sale of, suppliers' products. Thus, the organization's provision of 
exhibition space is not a qualified convention or trade show activity. 
Income derived from rentals of exhibition space to suppliers will be 
unrelated business taxable income under section 512.

[T.D. 7896, 48 FR 23817, May 27, 1983]



Sec. 1.513-4  Certain sponsorship not unrelated trade or business.

    (a) In general. Under section 513(i), the receipt of qualified 
sponsorship payments by an exempt organization which is subject to the 
tax imposed by section 511 does not constitute receipt of income from an 
unrelated trade or business.
    (b) Exception. The provisions of this section do not apply with 
respect to payments made in connection with qualified convention and 
trade show activities. For rules governing qualified convention and 
trade show activity, see Sec. 1.513-3. The provisions of this section 
also do not apply to income derived from the sale of advertising or 
acknowledgments in exempt organization periodicals. For this purpose, 
the term periodical means regularly scheduled and printed material 
published by or on behalf of the exempt organization that is not related 
to and primarily distributed in connection with a specific event 
conducted by the exempt organization. For this purpose, printed material 
includes material that is published electronically. For rules governing 
the sale of advertising in exempt organization periodicals, see Sec. 
1.512(a)-1(f).
    (c) Qualified sponsorship payment--(1) Definition. The term 
qualified sponsorship payment means any payment by any person engaged in 
a trade or business with respect to which there is no arrangement or 
expectation that the person will receive any substantial return benefit. 
In determining whether a payment is a qualified sponsorship payment, it 
is irrelevant whether the sponsored activity is related or unrelated to 
the recipient organization's exempt purpose. It is also irrelevant 
whether the sponsored activity is temporary or permanent. For purposes 
of this section, payment means the payment of money, transfer of 
property, or performance of services.
    (2) Substantial return benefit--(i) In general. For purposes of this 
section, a substantial return benefit means any benefit other than a use 
or acknowledgment described in paragraph (c)(2)(iv) of this section, or 
disregarded benefits described in paragraph (c)(2)(ii) of this section.
    (ii) Certain benefits disregarded. For purposes of paragraph 
(c)(2)(i) of this section, benefits are disregarded if the aggregate 
fair market value of all the benefits provided to the payor or persons 
designated by the payor in connection with the payment during the 
organization's taxable year is not more than 2% of the amount of the 
payment. If the aggregate fair market value of the benefits exceeds 2% 
of the amount of the payment, then (except as provided in paragraph 
(c)(2)(iv) of this section) the entire fair market value of such 
benefits, not merely the excess amount, is a substantial return benefit. 
Fair market value is determined as provided in paragraph (d)(1) of this 
section.
    (iii) Benefits defined. For purposes of this section, benefits 
provided to the payor or persons designated by the payor may include:
    (A) Advertising as defined in paragraph (c)(2)(v) of this section.
    (B) Exclusive provider arrangements as defined in paragraph 
(c)(2)(vi)(B) of this section.
    (C) Goods, facilities, services or other privileges.
    (D) Exclusive or nonexclusive rights to use an intangible asset 
(e.g., trademark, patent, logo, or designation) of the exempt 
organization.
    (iv) Use or acknowledgment. For purposes of this section, a 
substantial return benefit does not include the use or acknowledgment of 
the name or logo (or product lines) of the payor's trade or business in 
connection with the activities of the exempt organization. Use or 
acknowledgment does not include advertising as described in paragraph 
(c)(2)(v) of this section, but may

[[Page 198]]

include the following: exclusive sponsorship arrangements; logos and 
slogans that do not contain qualitative or comparative descriptions of 
the payor's products, services, facilities or company; a list of the 
payor's locations, telephone numbers, or Internet address; value-neutral 
descriptions, including displays or visual depictions, of the payor's 
product-line or services; and the payor's brand or trade names and 
product or service listings. Logos or slogans that are an established 
part of a payor's identity are not considered to contain qualitative or 
comparative descriptions. Mere display or distribution, whether for free 
or remuneration, of a payor's product by the payor or the exempt 
organization to the general public at the sponsored activity is not 
considered an inducement to purchase, sell or use the payor's product 
for purposes of this section and, thus, will not affect the 
determination of whether a payment is a qualified sponsorship payment.
    (v) Advertising. For purposes of this section, the term advertising 
means any message or other programming material which is broadcast or 
otherwise transmitted, published, displayed or distributed, and which 
promotes or markets any trade or business, or any service, facility or 
product. Advertising includes messages containing qualitative or 
comparative language, price information or other indications of savings 
or value, an endorsement, or an inducement to purchase, sell, or use any 
company, service, facility or product. A single message that contains 
both advertising and an acknowledgment is advertising. This section does 
not apply to activities conducted by a payor on its own. For example, if 
a payor purchases broadcast time from a television station to advertise 
its product during commercial breaks in a sponsored program, the exempt 
organization's activities are not thereby converted to advertising.
    (vi) Exclusivity arrangements--(A) Exclusive sponsor. An arrangement 
that acknowledges the payor as the exclusive sponsor of an exempt 
organization's activity, or the exclusive sponsor representing a 
particular trade, business or industry, generally does not, by itself, 
result in a substantial return benefit. For example, if in exchange for 
a payment, an organization announces that its event is sponsored 
exclusively by the payor (and does not provide any advertising or other 
substantial return benefit to the payor), the payor has not received a 
substantial return benefit.
    (B) Exclusive provider. An arrangement that limits the sale, 
distribution, availability, or use of competing products, services, or 
facilities in connection with an exempt organization's activity 
generally results in a substantial return benefit. For example, if in 
exchange for a payment, the exempt organization agrees to allow only the 
payor's products to be sold in connection with an activity, the payor 
has received a substantial return benefit.
    (d) Allocation of payment--(1) In general. If there is an 
arrangement or expectation that the payor will receive a substantial 
return benefit with respect to any payment, then only the portion, if 
any, of the payment that exceeds the fair market value of the 
substantial return benefit is a qualified sponsorship payment. However, 
if the exempt organization does not establish that the payment exceeds 
the fair market value of any substantial return benefit, then no portion 
of the payment constitutes a qualified sponsorship payment.
    (i) Treatment of payments other than qualified sponsorship payments. 
The unrelated business income tax (UBIT) treatment of any payment (or 
portion thereof) that is not a qualified sponsorship payment is 
determined by application of sections 512, 513 and 514. For example, 
payments related to an exempt organization's providing facilities, 
services, or other privileges to the payor or persons designated by the 
payor, advertising, exclusive provider arrangements described in 
paragraph (c)(2)(vi)(B) of this section, a license to use intangible 
assets of the exempt organization, or other substantial return benefits, 
are evaluated separately in determining whether the exempt organization 
realizes unrelated business taxable income.
    (ii) Fair market value. The fair market value of any substantial 
return benefit provided as part of a sponsorship arrangement is the 
price at which the benefit would be provided between a willing recipient 
and a willing provider

[[Page 199]]

of the benefit, neither being under any compulsion to enter into the 
arrangement and both having reasonable knowledge of relevant facts, and 
without regard to any other aspect of the sponsorship arrangement.
    (iii) Valuation date. In general, the fair market value of the 
substantial return benefit is determined when the benefit is provided. 
However, if the parties enter into a binding, written sponsorship 
contract, the fair market value of any substantial return benefit 
provided pursuant to that contract is determined on the date the parties 
enter into the sponsorship contract. If the parties make a material 
change to a sponsorship contract, it is treated as a new sponsorship 
contract as of the date the material change is effective. A material 
change includes an extension or renewal of the contract, or a more than 
incidental change to any amount payable (or other consideration) 
pursuant to the contract.
    (iv) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. On June 30, 2001, a national corporation and Z, a 
charitable organization, enter into a five-year binding, written 
contract effective for years 2002 through 2007. The contract provides 
that the corporation will make an annual payment of $5,000 to Z, and in 
return the corporation will receive no benefit other than advertising. 
On June 30, 2001, the fair market value of the advertising to be 
provided to the corporation in each year of the agreement is $75, which 
is less than the disregarded benefit amount provided for in paragraph 
(c)(2)(ii) of this section (2% of $5,000 is $100). In 2002, pursuant to 
the sponsorship contract, the corporation makes a payment to Z of 
$5,000, and receives the specified benefit (advertising). As of January 
1, 2002, the fair market value of the advertising to be provided by Z 
each year has increased to $110. However, for purposes of this section, 
the fair market value of the advertising benefit is determined on June 
30, 2001, the date the parties entered into the sponsorship contract. 
Therefore, the entire $5,000 payment received in 2002 is a qualified 
sponsorship payment.
    Example 2. The facts are the same as Example 1, except that the 
contract provides for an initial payment by the corporation to Z of 
$5,000 in 2002, followed by annual payments of $1,000 during each of 
years 2003-2007. In 2003, pursuant to the sponsorship contract, the 
corporation makes a payment to Z of $1,000, and receives the specified 
advertising benefit. In 2003, the fair market value of the benefit 
provided ($75, as determined on June 30, 2001) exceeds 2% of the total 
payment received (2% of $1,000 is $20). Therefore, only $925 of the 
$1,000 payment received in 2003 is a qualified sponsorship payment.

    (2) Anti-abuse provision. To the extent necessary to prevent 
avoidance of the rule stated in paragraphs (d)(1) and (c)(2) of this 
section, where the exempt organization fails to make a reasonable and 
good faith valuation of any substantial return benefit, the Commissioner 
(or the Commissioner's delegate) may determine the portion of a payment 
allocable to such substantial return benefit and may treat two or more 
related payments as a single payment.
    (e) Special rules--(1) Written agreements. The existence of a 
written sponsorship agreement does not, in itself, cause a payment to 
fail to be a qualified sponsorship payment. The terms of the agreement, 
not its existence or degree of detail, are relevant to the determination 
of whether a payment is a qualified sponsorship payment. Similarly, the 
terms of the agreement and not the title or responsibilities of the 
individuals negotiating the agreement determine whether a payment (or 
any portion thereof) made pursuant to the agreement is a qualified 
sponsorship payment.
    (2) Contingent payments. The term qualified sponsorship payment does 
not include any payment the amount of which is contingent, by contract 
or otherwise, upon the level of attendance at one or more events, 
broadcast ratings, or other factors indicating the degree of public 
exposure to the sponsored activity. The fact that a payment is 
contingent upon sponsored events or activities actually being conducted 
does not, by itself, cause the payment to fail to be a qualified 
sponsorship payment.
    (3) Determining public support. Qualified sponsorship payments in 
the form of money or property (but not services) are treated as 
contributions received by the exempt organization for purposes of 
determining public support to the organization under section 
170(b)(1)(A)(vi) or 509(a)(2). See Sec. Sec. 1.509(a)-3(f)(1) and 
1.170A-9(e)(6)(i). The fact that a payment is a qualified sponsorship 
payment that is treated as

[[Page 200]]

a contribution to the payee organization does not determine whether the 
payment is deductible by the payor under section 162 or 170.
    (f) Examples. The provisions of this section are illustrated by the 
following examples. The tax treatment of any payment (or portion of a 
payment) that does not constitute a qualified sponsorship payment is 
governed by general UBIT principles. In these examples, the recipients 
of the payments at issue are section 501(c) organizations. The 
expectations or arrangements of the parties are those specifically 
indicated in the example. The examples are as follows:

    Example 1. M, a local charity, organizes a marathon and walkathon at 
which it serves to participants drinks and other refreshments provided 
free of charge by a national corporation. The corporation also gives M 
prizes to be awarded to winners of the event. M recognizes the 
assistance of the corporation by listing the corporation's name in 
promotional fliers, in newspaper advertisements of the event and on T-
shirts worn by participants. M changes the name of its event to include 
the name of the corporation. M's activities constitute acknowledgment of 
the sponsorship. The drinks, refreshments and prizes provided by the 
corporation are a qualified sponsorship payment, which is not income 
from an unrelated trade or business.
    Example 2. N, an art museum, organizes an exhibition and receives a 
large payment from a corporation to help fund the exhibition. N 
recognizes the corporation's support by using the corporate name and 
established logo in materials publicizing the exhibition, which include 
banners, posters, brochures and public service announcements. N also 
hosts a dinner for the corporation's executives. The fair market value 
of the dinner exceeds 2% of the total payment. N's use of the corporate 
name and logo in connection with the exhibition constitutes 
acknowledgment of the sponsorship. However, because the fair market 
value of the dinner exceeds 2% of the total payment, the dinner is a 
substantial return benefit. Only that portion of the payment, if any, 
that N can demonstrate exceeds the fair market value of the dinner is a 
qualified sponsorship payment.
    Example 3. O coordinates sports tournaments for local charities. An 
auto manufacturer agrees to underwrite the expenses of the tournaments. 
O recognizes the auto manufacturer by including the manufacturer's name 
and established logo in the title of each tournament as well as on 
signs, scoreboards and other printed material. The auto manufacturer 
receives complimentary admission passes and pro-am playing spots for 
each tournament that have a combined fair market value in excess of 2% 
of the total payment. Additionally, O displays the latest models of the 
manufacturer's premier luxury cars at each tournament. O's use of the 
manufacturer's name and logo and display of cars in the tournament area 
constitute acknowledgment of the sponsorship. However, the admission 
passes and pro-am playing spots are a substantial return benefit. Only 
that portion of the payment, if any, that O can demonstrate exceeds the 
fair market value of the admission passes and pro-am playing spots is a 
qualified sponsorship payment.
    Example 4. P conducts an annual college football bowl game. P sells 
to commercial broadcasters the right to broadcast the bowl game on 
television and radio. A major corporation agrees to be the exclusive 
sponsor of the bowl game. The detailed contract between P and the 
corporation provides that in exchange for a $1,000,000 payment, the name 
of the bowl game will include the name of the corporation. In addition, 
the contract provides that the corporation's name and established logo 
will appear on player's helmets and uniforms, on the scoreboard and 
stadium signs, on the playing field, on cups used to serve drinks at the 
game, and on all related printed material distributed in connection with 
the game. P also agrees to give the corporation a block of game passes 
for its employees and to provide advertising in the bowl game program 
book. The fair market value of the passes is $6,000, and the fair market 
value of the program advertising is $10,000. The agreement is contingent 
upon the game being broadcast on television and radio, but the amount of 
the payment is not contingent upon the number of people attending the 
game or the television ratings. The contract provides that television 
cameras will focus on the corporation's name and logo on the field at 
certain intervals during the game. P's use of the corporation's name and 
logo in connection with the bowl game constitutes acknowledgment of the 
sponsorship. The exclusive sponsorship arrangement is not a substantial 
return benefit. Because the fair market value of the game passes and 
program advertising ($16,000) does not exceed 2% of the total payment 
(2% of $1,000,000 is $20,000), these benefits are disregarded and the 
entire payment is a qualified sponsorship payment, which is not income 
from an unrelated trade or business.
    Example 5. Q organizes an amateur sports team. A major pizza chain 
gives uniforms to players on Q's team, and also pays some of the team's 
operational expenses. The uniforms bear the name and established logo of 
the pizza chain. During the final tournament series, Q distributes free 
of charge souvenir flags bearing Q's name to employees of the pizza 
chain who come out to support the team. The flags are valued at less 
than 2% of

[[Page 201]]

the combined fair market value of the uniforms and operational expenses 
paid. Q's use of the name and logo of the pizza chain in connection with 
the tournament constitutes acknowledgment of the sponsorship. Because 
the fair market value of the flags does not exceed 2% of the total 
payment, the entire amount of the funding and supplied uniforms are a 
qualified sponsorship payment, which is not income from an unrelated 
trade or business.
    Example 6. R is a liberal arts college. A soft drink manufacturer 
enters into a binding, written contract with R that provides for a large 
payment to be made to the college's English department in exchange for R 
agreeing to name a writing competition after the soft drink 
manufacturer. The contract also provides that R will allow the soft 
drink manufacturer to be the exclusive provider of all soft drink sales 
on campus. The fair market value of the exclusive provider component of 
the contract exceeds 2% of the total payment. R's use of the 
manufacturer's name in the writing competition constitutes 
acknowledgment of the sponsorship. However, the exclusive provider 
arrangement is a substantial return benefit. Only that portion of the 
payment, if any, that R can demonstrate exceeds the fair market value of 
the exclusive provider arrangement is a qualified sponsorship payment.
    Example 7. S is a noncommercial broadcast station that airs a 
program funded by a local music store. In exchange for the funding, S 
broadcasts the following message: ``This program has been brought to you 
by the Music Shop, located at 123 Main Street. For your music needs, 
give them a call today at 555-1234. This station is proud to have the 
Music Shop as a sponsor.'' Because this single broadcast message 
contains both advertising and an acknowledgment, the entire message is 
advertising. The fair market value of the advertising exceeds 2% of the 
total payment. Thus, the advertising is a substantial return benefit. 
Unless S establishes that the amount of the payment exceeds the fair 
market value of the advertising, none of the payment is a qualified 
sponsorship payment.
    Example 8. T, a symphony orchestra, performs a series of concerts. A 
program guide that contains notes on guest conductors and other 
information concerning the evening's program is distributed by T at each 
concert. The Music Shop makes a $1,000 payment to T in support of the 
concert series. As a supporter of the event, the Music Shop receives 
complimentary concert tickets with a fair market value of $85, and is 
recognized in the program guide and on a poster in the lobby of the 
concert hall. The lobby poster states that, ``The T concert is sponsored 
by the Music Shop, located at 123 Main Street, telephone number 555-
1234.'' The program guide contains the same information and also states, 
``Visit the Music Shop today for the finest selection of music CDs and 
cassette tapes.'' The fair market value of the advertisement in the 
program guide is $15. T's use of the Music Shop's name, address and 
telephone number in the lobby poster constitutes acknowledgment of the 
sponsorship. However, the combined fair market value of the 
advertisement in the program guide and complimentary tickets is $100 
($15 + $85), which exceeds 2% of the total payment (2% of $1,000 is 
$20). The fair market value of the advertising and complimentary 
tickets, therefore, constitutes a substantial return benefit and only 
that portion of the payment, or $900, that exceeds the fair market value 
of the substantial return benefit is a qualified sponsorship payment.
    Example 9. U, a national charity dedicated to promoting health, 
organizes a campaign to inform the public about potential cures to fight 
a serious disease. As part of the campaign, U sends representatives to 
community health fairs around the country to answer questions about the 
disease and inform the public about recent developments in the search 
for a cure. A pharmaceutical company makes a payment to U to fund U's 
booth at a health fair. U places a sign in the booth displaying the 
pharmaceutical company's name and slogan, ``Better Research, Better 
Health,'' which is an established part of the company's identity. In 
addition, U grants the pharmaceutical company a license to use U's logo 
in marketing its products to health care providers around the country. 
The fair market value of the license exceeds 2% of the total payment 
received from the company. U's display of the pharmaceutical company's 
name and slogan constitutes acknowledgment of the sponsorship. However, 
the license granted to the pharmaceutical company to use U's logo is a 
substantial return benefit. Only that portion of the payment, if any, 
that U can demonstrate exceeds the fair market value of the license 
granted to the pharmaceutical company is a qualified sponsorship 
payment.
    Example 10. V, a trade association, publishes a monthly scientific 
magazine for its members containing information about current issues and 
developments in the field. A textbook publisher makes a large payment to 
V to have its name displayed on the inside cover of the magazine each 
month. Because the monthly magazine is a periodical within the meaning 
of paragraph (b) of this section, the section 513(i) safe harbor does 
not apply. See Sec. 1.512(a)-1(f).
    Example 11. W, a symphony orchestra, maintains a Web site containing 
pertinent information and its performance schedule. The Music Shop makes 
a payment to W to fund a concert series, and W posts a list of its 
sponsors on its Web site, including the Music Shop's name and Internet 
address. W's Web site does not promote the Music Shop or advertise its 
merchandise. The Music Shop's

[[Page 202]]

Internet address appears as a hyperlink from W's Web site to the Music 
Shop's Web site. W's posting of the Music Shop's name and Internet 
address on its Web site constitutes acknowledgment of the sponsorship. 
The entire payment is a qualified sponsorship payment, which is not 
income from an unrelated trade or business.
    Example 12. X, a health-based charity, sponsors a year-long 
initiative to educate the public about a particular medical condition. A 
large pharmaceutical company manufactures a drug that is used in 
treating the medical condition, and provides funding for the initiative 
that helps X produce educational materials for distribution and post 
information on X's Web site. X's Web site contains a hyperlink to the 
pharmaceutical company's Web site. On the pharmaceutical company's Web 
site, the statement appears, ``X endorses the use of our drug, and 
suggests that you ask your doctor for a prescription if you have this 
medical condition.'' X reviewed the endorsement before it was posted on 
the pharmaceutical company's Web site and gave permission for the 
endorsement to appear. The endorsement is advertising. The fair market 
value of the advertising exceeds 2% of the total payment received from 
the pharmaceutical company. Therefore, only the portion of the payment, 
if any, that X can demonstrate exceeds the fair market value of the 
advertising on the pharmaceutical company's Web site is a qualified 
sponsorship payment.

[T.D. 8991, 67 FR 20438, Apr. 25, 2002]



Sec. 1.513-5  Certain bingo games not unrelated trade or business.

    (a) In general. Under section 513(f), and subject to the limitations 
in paragraph (C) of this section, in the case of an organization subject 
to the tax imposed by section 511, the term unrelated trade or business 
does not include any trade or business that consists of conducting bingo 
games (as defined in paragraph (d) of this section).
    (b) Exception. The provisions of this section shall not apply with 
respect to any bingo game otherwise excluded from the term unrelated 
trade or business by reason of section 513(a)(1) and Sec. 1.513-1(e)(1) 
(relating to trades or businesses in which substantially all the work is 
performed without compensation).
    (c) Limitations--(1) Bingo games must be legal. Paragraph (a) of 
this section shall not apply with respect to any bingo game conducted in 
violation of State or local law.
    (2) No commercial competition. Paragraph (a) of this section shall 
not apply with respect to any bingo game conducted in a jurisdiction in 
which bingo games are ordinarily carried out on a commercial basis. 
Bingo games are ordinarily carried out on a commercial basis within a 
jursidiction if they are regularly carried on (within the meaning of 
Sec. 1.513-1(c)) by for-profit organizations in any part of that 
jurisidiction. Normally, the entire State will constitute the 
appropriate jurisdiction for determining whether bingo games are 
ordinarily carried out on a commercial basis. However, if State law 
permits local jurisdictions to determine whether bingo games may be 
conducted by for-profit organizations, or if State law limits or 
confines the conduct of bingo games by for-profit organizations to 
specific local jurisdictions, then the local jurisdiction will 
constitute the appropriate jurisdiction for determining whether bingo 
games are ordinarily carried out on a commercial basis.
    (3) Examples. The application of this paragraph is illustrated by 
the examples that follow. In each example, it is assumed that the bingo 
games referred to are operated by individuals who are compensated for 
their services. Accordingly, none of the bingo games would be excluded 
from the term unrelated trade or business under section 513 (a) (1).

    Example 1. Church Z, a tax-exempt organization, conducts weekly 
bingo games in State O. State and local laws in State O expressly 
provide that bingo games may be conducted by tax-exempt organizations. 
Bingo games are not conducted in State O by any for-profit businesses. 
Since Z's bingo games are not conducted in violation of State or local 
law and are not the type of activity ordinarily carried out on a 
commercial basis in State O, Z's bingo games do not constitute unrelated 
trade or business.
    Example 2. Rescue Squad X, a tax-exempt organization, conducts 
weekly bingo games in State M. State M has a statutory provision that 
prohibits all forms of gambling including bingo games. However, that law 
generally is not enforced by State officials against local charitable 
organizations such as X that conduct bingo games to raise funds. Since 
bingo games are illegal under State law, X's bingo games constitute 
unrelated trade or business regardless of the degree to which the State 
law is enforced.

[[Page 203]]

    Example 3. Veteran's organizations Y and X, both tax-exempt 
organizations, are organized under the laws of State N. State N has a 
statutory provision that permits bingo games to be conducted by tax-
exempt organizations. In addition, State N permits bingo games to be 
conducted by for-profit organizations in city S, a resort community 
located in county R. Several for-profit organizations conduct nightly 
bingo games in city S. Y conducts weekly bingo games in city S. X 
conducts weekly bingo games in county R. Since State law confines the 
conduct of bingo games by for-profit organizations to city S, and since 
bingo games are regularly carried on there by those organizations, Y's 
bingo games conducted in city S constitute unrelated trade or business. 
However, X's bingo games conducted in county R outside of city S do not 
constitute unrelated trade or business.

    (d) Bingo game defined. A bingo game is a game of chance played with 
cards that are generally printed with five rows of five squares each. 
Participants place markers over randomly called numbers on the cards in 
an attempt to form a preselected pattern such as a horizontal, vertical, 
or diagonal line, or all four corners. The first participant to form the 
preselected pattern wins the game. As used in this section, the term 
bingo game means any game of bingo of the type described above in which 
wagers are placed, winners are determined, and prizes or other property 
is distributed in the presence of all persons placing wagers in that 
game. The term bingo game does not refer to any game of chance 
(including, but not limited to, keno games, dice games, card games, and 
lotteries) other than the type of game described in this paragraph.
    (e) Effective date. Section 513(f) and this section apply to taxable 
years beginning after December 31, 1969.

[T.D. 7699, 45 FR 33970, May 21, 1980]



Sec. 1.513-6  Certain hospital services not unrelated trade or business.

    (a) In general. Under section 513(e), the furnishing of a service 
listed in section 501(e)(1)(A) by a hospital to one or more other 
hospitals will not constitute unrelated trade or business if--
    (1) The service is provided solely to hospitals that have facilities 
to serve not more than 100 inpatients,
    (2) The service would, if performed by the recipient hospital, 
constitute an activity consistent with that hospital's exempt purposes, 
and
    (3) The service is provided at a fee not in excess of actual cost, 
including straight line depreciation and a reasonable rate of return on 
the capital goods used to provide the service. For purposes of this 
section, a rate of return on capital goods will be considered reasonable 
provided that it does not exceed, on an annual basis, the percentage 
described below which is based on the average of the rates of interest 
on special issues of public debt obligations issued to the Federal 
Hospital Insurance Trust Fund for each of the months included in the 
taxable year of the hospital duringwhich the captial goods are used in 
providing the service. Determinations as to the cost of services and the 
applicable rate of return should be made as prescribed by 42 U.S.C. 
1395x(v)(1) (A) and (B) and the regulations thereunder (permitting a 
health care facility to be reimbursed under the Medicare program for the 
reasonable cost of (its) services, including, in the case of certain 
proprietary facilities, a reasonable return on equity capital). For 
taxable years beginning on or before May 14, 1986, the rate of return 
shall be one and one-half times the average of the rates of interest on 
public debt obligations described above which were in effect on or 
before April 20, 1983.
    (b) Hospital defined. As used in this section the word hospital 
means a hospital described in section 170(b)(1)(A)(iii).
    (c) Example. The provisions of this section are illustrated by the 
following example:

    Example. A large metropolitan hospital provides various services to 
other hospitals. The hospital furnishes a purchasing service to 
hosptials N and O, a data processing service to hospitals R and S, and a 
food service to hospitals X and Y. All the hospitals are described in 
section 170(b)(1)(A)(iii). All the hospitals have facilities to serve 
not more than 100 inpatients except hospital N. The services are 
furnished at cost to all hospitals except that hospital R is charged a 
fee in excess of cost for its use of the data processing service. The 
purchasing service constitutes unrelated trade or business because it is 
not provided solely to hospitals having facilities to serve not more 
than 100 inpatients.

[[Page 204]]

    The data processing service constitutes unrelated trade or business 
because it is provided at a fee in excess of cost. The food service 
satisfies all three requirements of paragraph (a) of this section and 
does not constitute unrelated trade or business.

    (d) Effective date. Section 513(e) and this section apply to taxable 
years beginning after December 31, 1953.

[T.D. 8075, 51 FR 5322, Feb. 13, 1986; 51 FR 8490, Mar. 12, 1986]



Sec. 1.513-7  Travel and tour activities of tax exempt organizations.

    (a) Travel tour activities that constitute a trade or business, as 
defined in Sec. 1.513-1(b), and that are not substantially related to 
the purposes for which exemption has been granted to the organization 
constitute an unrelated trade or business with respect to that 
organization. Whether travel tour activities conducted by an 
organization are substantially related to the organization's exempt 
purpose is determined by looking at all relevant facts and 
circumstances, including, but not limited to, how a travel tour is 
developed, promoted and operated. Section 513(c) and Sec. 1.513-1(b) 
also apply to travel tour activity. Application of the rules of section 
513(c) and Sec. 1.513-1(b) may result in different treatment for 
individual tours within an organization's travel tour program.
    (b) Examples. The provisions of this section are illustrated by the 
following examples. In all of these examples, the travel tours are 
priced to produce a profit for the exempt organization. The examples are 
as follows:

    Example 1. O, a university alumni association, is exempt from 
federal income tax under section 501(a) as an educational organization 
described in section 501(c)(3). As part of its activities, O operates a 
travel tour program. The program is open to all current members of O and 
their guests. O works with travel agencies to schedule approximately 10 
tours annually to various destinations around the world. Members of O 
pay $x to the organizing travel agency to participate in a tour. The 
travel agency pays O a per person fee for each participant. Although the 
literature advertising the tours encourages O's members to continue 
their lifelong learning by joining the tours, and a faculty member of 
O's related university frequently joins the tour as a guest of the 
alumni association, none of the tours includes any scheduled instruction 
or curriculum related to the destinations being visited. The travel 
tours made available to O's members do not contribute importantly to the 
accomplishment of O's educational purpose. Rather, O's program is 
designed to generate revenues for O by regularly offering its members 
travel services. Accordingly, O's tour program is an unrelated trade or 
business within the meaning of section 513(a).
    Example 2. N is an organization formed for the purpose of educating 
individuals about the geography and culture of the United States. It is 
exempt from federal income tax under section 501(a) as an educational 
and cultural organization described in section 501(c)(3). N engages in a 
number of activities to accomplish its purposes, including offering 
courses and publishing periodicals and books. As one of its activities, 
N conducts study tours to national parks and other locations within the 
UnitedStates. The study tours are conducted by teachers and other 
personnel certified by the Board of Education of the State of P. The 
tours are directed toward students enrolled in degree programs at 
educational institutions in P, as reflected in the promotional 
materials, but are open to all who agree to participate in the required 
study program. Each tour's study program consists of instruction on 
subjects related to the location being visited on the tour. During the 
tour, five or six hours per day are devoted to organized study, 
preparation of reports, lectures, instruction and recitation by the 
students. Each tour group brings along a library of material related to 
the subject being studied on the tour. Examinations are given at the end 
of each tour and the P StateBoard of Education awards academic credit 
for tour participation. Because the tours offered by N include a 
substantial amount of required study, lectures, report preparation, 
examinations and qualify for academic credit, the tours are 
substantially related to N's educational purpose. Accordingly, N's tour 
program is not an unrelated trade or business within the meaning of 
section 513(a).
    Example 3. R is a section 501(c)(4) social welfare organization 
devoted to advocacy on a particular issue. On a regular basis throughout 
the year, R organizes travel tours for its members to Washington, DC. 
While in Washington, the members follow a schedule according to which 
they spend substantially all of their time during normal business hours 
over several days attending meetings with legislators and government 
officials and receiving briefings on policy developments related to the 
issue that is R's focus. Members do have some time on their own in the 
evenings to engage in recreational or social activities of their own 
choosing. Bringing members to Washington to participate in advocacy on 
behalf of the organization and learn about developments relating to the 
organization's principal focus

[[Page 205]]

is substantially related to R's social welfare purpose. Therefore, R's 
operation of the travel tours does not constitute an unrelated trade or 
business within the meaning of section 513(a).
    Example 4. S is a membership organization formed to foster cultural 
unity and to educate X Americans about X, their country of origin. It is 
exempt from federal income tax under section 501(a) and is described in 
section 501(c)(3) as an educational and cultural organization. 
Membership in S is open to all Americans interested in the X heritage. 
As part of its activities, S sponsors a program of travel tours to X. 
The tours are divided into two categories. Category A tours are trips to 
X that are designed to immerse participants in the X history, culture 
and language. Substantially all of the daily itinerary includes 
scheduled instruction on the X language, history and cultural heritage, 
and visits to destinations selected because of their historical or 
cultural significance or because of instructional resources they offer. 
Category B tours are also trips to X, but rather than offering scheduled 
instruction, participants are given the option of taking guided tours of 
various X locations included in their itinerary. Other than the optional 
guided tours, Category B tours offer no instruction or curriculum. 
Destinations of principally recreational interest, rather than 
historical or cultural interest, are regularly included on Category B 
tour itineraries. Based on the facts and circumstances, sponsoring 
Category A tours is an activity substantially related to S's exempt 
purposes, and does not constitute an unrelated trade or business within 
the meaning of section 513(a). However, sponsoring Category B tours does 
not contribute importantly to S's accomplishment of its exempt purposes 
and, thus, constitutes an unrelated trade or business within the meaning 
of section 513(a).
    Example 5. T is a scientific organization engaged in environmental 
research. T is exempt from federal income tax under section 501(a ) as 
an organization described in section 501(c)(3). T is engaged in a long-
term study of how agricultural pesticide and fertilizer use affects the 
populations of various bird species. T collects data at several bases 
located in an important agricultural region of country U. The minutes of 
a meeting of T's Board of Directors state that, after study, the Board 
has determined that non-scientists can reliably perform needed data 
collection in the field, under supervision of T's biologists. The Board 
minutes reflect that the Board approved offering one-week trips to T's 
bases in U, where participants will assist T's biologists in collecting 
data for the study. Tour participants collect data during the same hours 
as T's biologists. Normally, data collection occurs during the early 
morning and evening hours, although the work schedule varies by season. 
Each base has rustic accommodations and few amenities, but country U is 
renowned for its beautiful scenery and abundant wildlife. T promotes the 
trips in its newsletter and on its Internet site and through various 
conservation organizations. The promotional materials describe the work 
schedule and emphasize the valuable contribution made by trip 
participants to T's research activities. Based on the facts and 
circumstances, sponsoring trips to T's bases in country U is an activity 
substantially related to T's exempt purpose, and, thus, does not 
constitute an unrelated trade or business within the meaning of section 
513(a).
    Example 6. V is an educational organization devoted to the study of 
ancient history and cultures and is exempt from federal income tax under 
section 501(a) as an organization described in section 501(c)(3). In 
connection with its educational activities, V conducts archaeological 
expeditions around the world, including in the Y region of country Z. In 
cooperation with the National Museum of Z, V recently presented an 
exhibit on ancient civilizations of the Y region of Z, including 
artifacts from the collection of the Z National Museum. V instituted a 
program of travel tours to V's archaeological sites located in the Y 
region. The tours were initially proposed by V staff members as a means 
of educating the public about ongoing field research conducted by V. V 
engaged a travel agency to handle logistics such as accommodations and 
transportation arrangements. In preparation for the tours, V developed 
educational materials relating to each archaeological site to be visited 
on the tour, describing in detail the layout of the site, the methods 
used by V's researchers in exploring the site, the discoveries made at 
the site, and their historical significance. V also arranged special 
guided tours of its exhibit on the Y region for individuals registered 
for the travel tours. Two archaeologists from V (both of whom had 
participated in prior archaeological expeditions in the Y region) 
accompanied the tours. These experts led guided tours of each site and 
explained the significance of the sites to tour participants. At several 
of the sites, tour participants also met with a working team of 
archaeologists from V and the National Museum of Z, who shared their 
experiences. V prepared promotional materials describing the educational 
nature of the tours, including the daily trips to V's archaeological 
sites and the educational background of the tour leaders, and providing 
a recommended reading list. The promotional materials do not refer to 
any particular recreational or sightseeing activities. Based on the 
facts and circumstances, sponsoring trips to the Y region is an activity 
substantially related to V's exempt purposes. The scheduled activities, 
which include tours of archaeological sites

[[Page 206]]

led by experts, are part of a coordinated educational program designed 
to educate tour participants about the ancient history of the Y region 
of Z and V's ongoing field research. Therefore, V's tour program does 
not constitute an unrelated trade or business within the meaning of 
section 513(a).
    Example 7. W is an educational organization devoted to the study of 
the performing arts and is exempt from federal income tax under section 
501(a) as an organization described in section 501(c)(3). In connection 
with its educational activities, W presents public performances of 
musical and theatrical works. Individuals become members of W by making 
an annual contribution to W of $q. Each year, W offers members an 
opportunity to travel as a group to one or more major cities in the 
United States or abroad. In each city, tour participants are provided 
tickets to attend a public performance of a play, concert or dance 
program each evening. W also arranges a sightseeing tour of each city 
and provides evening receptions for tour participants. W views its tour 
program as an important means to develop and strengthen bonds between W 
and its members, and to increase their financial and volunteer support 
of W. W engaged a travel agency to handle logistics such as 
accommodations and transportation arrangements. No educational materials 
are prepared by W or provided to tour participants in connection with 
the tours. Apart from attendance at the evening cultural events, the 
tours offer no scheduled instruction, organized study or group 
discussion. Although several members of W's administrative staff 
accompany each tour group, their role is to facilitate member 
interaction. The staff members have no special expertise in the 
performing arts and play no educational role in the tours. W prepared 
promotional materials describing the sightseeing opportunities on the 
tours and emphasizing the opportunity for members to socialize 
informally and interact with one another and with W staff members, while 
pursuing shared interests. Although W's tour program may foster goodwill 
among W members, it does not contribute importantly to W's educational 
purposes. W's tour program is primarily social and recreational in 
nature. The scheduled activities, which include sightseeing and 
attendance at various cultural events, are not part of a coordinated 
educational program. Therefore, W's tour program is an unrelated trade 
or business within the meaning of section 513(a).

[T.D. 8874, 65 FR 5773, Feb. 7, 2000; 65 FR 16143, Mar. 27, 2000]



Sec. 1.514(a)-1  Unrelated debt-financed income and deductions.

    (a) Income includible in gross income:
    (1) Percentage of income taken into account--(i) In general. For 
taxable years beginning after December 31, 1969, there shall be included 
with respect to each debt-financed property (as defined in section 514 
and Sec. 1.514(b)-1) as an item of gross income derived from an 
unrelated trade or business the amount of unrelated debt-financed income 
(as defined in subdivision (ii) of this subparagraph). See paragraph 
(a)(5) of Sec. 1.514(c)-1 for special rules regarding indebtedness 
incurred before June 28, 1966, applicable for taxable years beginning 
before January 1, 1972, and for special rules applicable to churches or 
conventions or associations of churches.
    (ii) Unrelated debt-financed income. The unrelated debt-financed 
income with respect to each debt-financed property is an amount which is 
the same percentage (but not in excess of 100 percent) of the total 
gross income derived during the taxable year from or on account of such 
property as:
    (a) The average acquisition indebtedness (as defined in subparagraph 
(3) of this paragraph) with respect to the property is of
    (b) The average adjusted basis of such property (as defined in 
subparagraph (2) of this paragraph).
    (iii) Debt/basis percentage. The percentage determined under 
subdivision (ii) of this subparagraph is hereinafter referred to as the 
debt/basis percentage.
    (iv) Example. Subdivisions (i), (ii), and (iii) of this subparagraph 
are illustrated by the following example. For purposes of this example 
it is assumed that the property is debt-financed property.

    Example. X, an exempt trade association, owns an office building 
which in 1971 produces $10,000 of gross rental income. The average 
adjusted basis of the building for 1971 is $100,000, and the average 
acquisition indebtedness with respect to the building for 1971 is 
$50,000. Accordingly, the debt/basis percentage for 1971 is 50 percent 
(the ratio of $50,000 to $100,000). Therefore, the unrelated debt-
financed income with respect to the building for 1971 is $5,000 (50 
percent of $10,000).

    (v) Gain from sale or other disposition. If debt-financed property 
is sold or otherwise disposed of, there shall be included in computing 
unrelated business taxable income an amount with respect

[[Page 207]]

to such gain (or loss) which is the same percentage (but not in excess 
of 100 percent) of the total gain (or loss) derived from such sale or 
other disposition as:
    (a) The highest acquisition indebtedness with respect to such 
property during the 12-month period, preceding the date of disposition, 
is of
    (b) The average adjusted basis of such property.

The tax on the amount of gain (or loss) included in unrelated business 
taxable income pursuant to the preceding sentence shall be determined in 
accordance with the rules set forth in subchapter P, chapter 1 of the 
Code (relating to capital gains and losses). See also section 511(d) and 
the regulations thereunder (relating to the minimum tax for tax 
preferences).
    (2) Average adjusted basis--(i) In general. The average adjusted 
basis of debt-financed property is the average amount of the adjusted 
basis of such property during that portion of the taxable year it is 
held by the organization. This amount is the average of:
    (a) The adjusted basis of such property as of the first day during 
the taxable year that the organization holds the property, and
    (b) The adjusted basis of such property as of the last day during 
the taxable year that the organization holds the property


See section 1011 and the regulations thereunder for determination of the 
adjusted basis of property.
    (ii) Adjustments for prior taxable years. For purposes of 
subdivision (i) of this subparagraph, the determination of the average 
adjusted basis of debt-financed property is not affected by the fact 
that the organization was exempt from taxation for prior taxable years. 
Proper adjustment must be made under section 1011 for the entire period 
since the acquisition of the property. For example, adjustment must be 
made for depreciation for all prior taxable years whether or not the 
organization was exempt from taxation for any such years. Similarly, the 
fact that only a portion of the depreciation allowance may be taken into 
account in computing the percentage of deductions allowable under 
section 514(a)(2) does not affect the amount of the adjustment for 
depreciation which is used in determining average adjusted basis.
    (iii) Cross reference. For the determination of the basis of debt-
financed property acquired in a complete or partial liquidation of a 
corporation in exchange for its stock, see Sec. 1.514(d)-1.
    (iv) Example. This subparagraph may be illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.

    Example. On July 10, 1970, X, an exempt educational organization, 
purchased an office building for $510,000, using $300,000 of borrowed 
funds. During 1970 the only adjustment to basis is $20,000 for 
depreciation. As of December 31, 1970, the adjusted basis of the 
building is $490,000 and the indebtedness is still $300,000. X files its 
return on a calendar year basis. Under these circumstances, the debt/
basis percentage for 1970 is 60 percent, calculated in the following 
manner:

 
                                                                Basis
 
As of July 10, 1970 (acquisition date).....................     $510,000
As of December 31, 1970....................................      490,000
                                                            ------------
    Total..................................................    1,000,000
 


Average Adjusted basis:
[GRAPHIC] [TIFF OMITTED] TC08OC91.000

Debt/basis percentage:

Average acquisition indebtedness ($300,000)/Average adjusted basis 
($500,000)=60 percent

For an illustration of the determination of the debt/basis percentage as 
changes in the acquisition indebtedness occur, see example 1 of 
subparagraph (3)(iii) of this paragraph.

    (3) Average acquisition indebtedness--(i) In general. The average 
acquisition indebtedness with respect to debt-financed property is the 
average amount of the outstanding principal indebtedness during that 
portion of the taxable year the property is held by the organization.
    (ii) Computation. The average acquisition indebtedness is computed 
by determining the amount of the outstanding principal indebtedness on 
the first day in each calendar month during the taxable year that the 
organization holds the property, adding these amounts together, and then 
dividing this sum by the total number of months during the taxable year 
that the organization held such property. A fractional part of a month 
shall be

[[Page 208]]

treated as a full month in computing average acquisition indebtedness.
    (iii) Examples. The application of this subparagraph may be 
illustrated by the following examples. For purposes of these examples it 
is assumed that the property is debt-financed property.

    Example 1. Assume the facts as stated in the example in subparagraph 
(2)(iv) of this paragraph, except that beginning July 20, 1970, the 
organization makes payments of $21,000 a month ($20,000 of which is 
attributable to principal and $1,000 to interest). In this situation, 
the average acquisition indebtedness for 1970 is $250,000. Thus, the 
debt/basis percentage for 1970 is 50 percent, calculated in the 
following manner:

 
                                                           Indebtedness
                                                           on the first
                                                            day in each
                                                          calendar month
                                                             that the
                                                            property is
                                                               held
 
Month:
  July..................................................        $300,000
  August................................................         280,000
  September.............................................         260,000
  October...............................................         240,000
  November..............................................         220,000
  December..............................................         200,000
                                                         ---------------
      Total.............................................       1,500,000
 

Average acquisition indebtedness:
$1,500,000/6 months=$250,000

Debt/basis percentage:
Average acquisition indebtedness ($250,000)/Average adjusted basis 
($500,000)=50 percent
    Example 2. Y, an exempt organization, owns stock in a corporation 
which it does not control. At the beginning of the year, Y has an 
outstanding principal indebtedness with respect to such stock of 
$12,000. Such indebtedness is paid off at the rate of $2,000 per month 
beginning January 30, so that it is retired at the end of 6 months. The 
average acquisition indebtedness for the taxable year is $3,500, 
calculated in the following manner:

 
                                                           Indebtedness
                                                           on the first
                                                            day in each
                                                          calendar month
                                                             that the
                                                            property is
                                                               held
 
Month:
  January...............................................         $12,000
  February..............................................          10,000
  March.................................................           8,000
  April.................................................           6,000
  May...................................................           4,000
  June..................................................           2,000
  July thru December....................................               0
                                                         ---------------
      Total.............................................          42,000
 

Average acquisition indebtedness:
[GRAPHIC] [TIFF OMITTED] TC08OC91.001

    (4) Indeterminate price--(i) In general. If an exempt organization 
acquires (or improves) property for an indeterminate price, the initial 
acquisition indebtedness and the unadjusted basis shall be determined in 
accordance with subdivisions (ii) and (iii) of this paragraph, unless 
the organization has obtained the consent of the Commissioner to use 
another method to compute such amounts.
    (ii) Unadjusted basis. For purposes of this subparagraph, the 
unadjusted basis of property (or of an improvement) is the fair market 
value of the property (or improvement) on the date of acquisition (or 
the date of completion of the improvement). The average adjusted basis 
of such property shall be determined in accordance with paragraph (a)(2) 
of this section.
    (iii) Initial acquisition indebtedness. For purposes of this 
subparagraph, the initial acquisition indebtedness is the fair market 
value of the property (or improvement) on the date of acquisition (or 
the date of completion of the improvement) less any down payment or 
other initial payment applied to the principal indebtedness. The average 
acquisition indebtednessith respect to such property shall be computed 
in accordance with paragraph (a)(3) of this section.
    (iv) Example. The application of this subparagraph may be 
illustrated by the following example. For purposes of this example it is 
assumed that the property is debt-financed property.

    Example. On January 1, 1971, X, an exempt trade association, 
acquires an office building for a down payment of $310,000 and an 
agreement to pay 10 percent of the income generated by the building for 
10 years. Neither the sales price nor the amount which X is obligated to 
pay in the future is certain. The fair market value of the building on 
the date of acquisition is $600,000. The depreciation allowance for 1971 
is $40,000. Unless X obtains the consent of the Commissioner to use 
another method, the unadjusted basis of the property is $600,000 (the 
fair market value of the property on the date of acquisition), and the 
initial acquisition indebtedness is $290,000 (fair market value of 
$600,000 less initial payment of $310,000). Under these circumstances, 
the average adjusted basis of the property for 1971 is $580,000, 
calculated as follows:


[[Page 209]]


[Initial fair market value+(initial fair market value less 
depreciation)] /2=[$600,000+($600,000-$40,000)] /2=$580,000.

    If no payment other than the initial payment is made in 1971, the 
average acquisition indebtedness for 1971 is $290,000. Thus, the debt/
basis percentage for 1971 is 50 percent, calculated as follows:

Average acquisition indebtedness /average adjusted basis=$290,000 /
$580,000=50 percent

    (b) Deductions--(1) Percentage of deductions taken into account. 
Except as provided in subparagraphs (4) and (5) of this paragraph, there 
shall be allowed as a deduction with respect to each debt-financed 
property an amount determined by applying the debt/basis percentage to 
the sum of the deductions allowable under subparagraph (2) of this 
paragraph.
    (2) Deductions allowable. The deductions allowable are those items 
allowed as deductions by chapter 1 of the Code which are directly 
connected with the debt-financed property or the income therefrom 
(including the dividends received deductions allowed by sections 243, 
244, and 245), except that:
    (i) The allowable deductions are subject to the modifications 
provided by section 512(b) on computation of the unrelated business 
taxable income, and
    (ii) If the debt-financed property is of a character which is 
subject to the allowance for depreciation provided in section 167, such 
allowance shall be computed only by use of the straight-line method of 
depreciation.
    (3) Directly connected with. To be directly connected with debt-
financed property or the income therefrom, an item of deduction must 
have proximate and primary relationship to such property or the income 
therefrom. Expenses, depreciation, and similar items attributable solely 
to such property are proximately and primarily related to such property 
or the income therefrom, and therefore qualify for deduction, to the 
extent they meet the requirements of subparagraph (2) of this paragraph. 
Thus, for example, if the straight-line depreciation allowance for an 
office building is $10,000 a year, an organization would be allowed a 
deduction for depreciation of $10,000 if the entire building were debt-
financed property. However, if only one-half of the building were 
treated as debt-financed property, then the depreciation allowed as a 
deduction would be $5,000. (See example 2 of Sec. 1.514(b)-
1(b)(1)(iii).)
    (4) Capital losses--(i) In general. If the sale or exchange of debt-
financed property results in a capital loss, the amount of such loss 
taken into account in the taxable year in which the loss arises shall be 
computed in accordance with paragraph (a)(1)(v) of this section. If, 
however, any portion of such capital loss not taken into account in such 
year may be carried back or carried over to another taxable year, the 
debt/basis percentage is not applied to determine what portion of such 
capital loss may be taken as a deduction in the year to which such 
capital loss is carried.
    (ii) Example. This subparagraph is illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.

    Example. X, an exempt educational organization, owns securities 
which are capital assets and which it has held for more than 6 months. 
In 1972 X sells the securities at a loss of $20,000. The debt/basis 
percentage with respect to computing the gain (or loss) derived from the 
sale of the securities is 40 percent. Thus, X has sustained a capital 
loss of $8,000 (40 percent of $20,000) with respect to the sale of the 
securities. For 1972 and the preceding three taxable years X has no 
other capital transactions. Under these circumstances, the $8,000 of 
capital loss may be carried over to the succeeding 5 taxable years 
without further application of the debt/basis percentage.

    (5) Net operating loss--(i) In general. If, after applying the debt/
basis percentage to the income derived from debt-financed property and 
the deductions directly connected with such income, such deductions 
exceed such income, the organization has sustained a net operating loss 
for the taxable year. This amount may be carried back or carried over to 
other taxable years in accordance with section 512(b)(6). However, the 
debt/ basis percentage shall not be applied in such other years to 
determine the amounts that may be taken as a deduction in those years.
    (ii) Example. This subparagraph may be illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.


[[Page 210]]


    Example. During 1974, Y, an exempt organization, receives $20,000 of 
rent from a building which it owns. Y has no other unrelated business 
taxable income for 1974. For 1974 the deductions directly connected with 
this building are property taxes of $5,000, interest of $5,000 on the 
acquisition indebtedness, and salary of $15,000 to the manager of the 
building. The debt/basis percentage for 1974 with respect to the 
building is 50 percent. Under these circumstances, Y shall take into 
account in computing its unrelated business taxable income for 1974, 
$10,000 of income (50 percent of $20,000) and $12,500 (50 percent of 
$25,000) of the deductions directly connected with such income. Thus, 
for 1974 Y has sustained a net operating loss of $2,500 ($10,000 of 
income less $12,500 of deductions) which may be carried back or carried 
over to other taxable years without further application of the debt/
basis percentage.

[T.D. 7229, 37 FR 28143, Dec. 21, 1972]



Sec. 1.514(a)-2  Business lease rents and deductions for taxable years 

beginning before January 1, 1970.

    (a) Effective date. This section applies to taxable years beginning 
before January 1, 1970.
    (b) In general--(1) Rents includible in gross income. There shall be 
included with respect to each business lease, as an item of gross income 
derived from an unrelated trade or business, an amount which is the same 
percentage (but not in excess of 100 percent) of the total rents derived 
during the taxable year under such lease as:
    (i) The amount of the business lease indebtedness at the close of 
the taxable year of the lessor tax-exempt organization, with respect to 
the premises covered by such lease, is of
    (ii) The adjusted basis of such premises at the close of such 
taxable year


For definition of business lease as a lease for a term of more than 5 
years, and for rules for determining the computation of such 5-year term 
in certain specific situations, see Sec. 1.514(f)-1. For definition of 
business lease indebtedness and allocation of business lease 
indebtedness where only a portion of the property is subject to a 
business lease, see Sec. 1.514(g)-1.
    (2) Determination of basis. For purposes of the unrelated business 
income tax the basis (unadjusted) of property is determined under 
section 1012, and the adjusted basis of property is determined under 
section 1011. The determination of the adjusted basis of property is not 
affected by the fact that the organization was exempt from tax for prior 
taxable years. Proper adjustment must be made under section 1011 for the 
entire period since the acquisition of the property. Thus adjustment 
must be made for depreciation for all taxable years whether or not the 
organization was exempt from tax for any of such years. Similarly, for 
taxable years during which the organization is subject to the tax on 
unrelated business taxable income the fact that only a portion of the 
deduction for depreciation is taken into account under paragraph (c)(1) 
of this section does not affect the amount of the adjustment for 
depreciation.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples, in each of which it is assumed that the 
taxpayer makes its returns under section 511 on the basis of the 
calendar year, and that the lease is not substantially related to the 
purpose for which the organization is granted exemption from tax.

    Example 1. Assume that a tax-exempt educational organization 
purchased property in 1952 for $600,000, using borrowed funds, and 
leased the building for a period of 20 years. Assume further that the 
adjusted basis of such building at the close of 1954 is $500,000 and 
that, at the close of 1954, $200,000 of the indebtedness incurred to 
acquire the property remains outstanding. Since the amount of the 
outstanding indebtedness is two-fifths of the adjusted basis of the 
building at the close of 1954, two-fifths of the gross rental received 
from the building during 1954 shall be included as an item of gross 
income in computing unrelated business taxable income. If, at the close 
of a subsequent taxable year, the outstanding indebtedness is $100,000 
and the adjusted basis of the building is $400,000, one-fourth of the 
gross rental for such taxable year shall be included as an item of gross 
income in computing unrelated business taxable income for such taxable 
year.
    Example 2. Assume that a tax-exempt organization owns a four-story 
building, that in 1954 it borrows $100,000 which it uses to improve the 
whole building, and that it thereafter in 1954 rents the first and 
second floors of the building under six-year leases at rentals of $4,000 
a year. The third and fourth floors of the building are leased on a 
yearly basis during 1954. Assume, also, that the adjusted basis of the 
real property at the end of 1954 (after reflecting the expenditures for 
improving the building) is $200,000, allocable equally to each of the 
four stories. Under

[[Page 211]]

these facts, only one-half of the real property is subject to a business 
lease since only one-half is rented under a lease for more than 5 years. 
See Sec. 1.514(f)-1. The percentage of the rent under such lease which 
is taken into account is determined by the ratio which the allocable 
part of the business lease indebtedness bears to the allocable part of 
the adjusted basis of the real property, that is, the ratio which one-
half of the $100,000 of business lease indebtedness outstanding at the 
close of 1954, or $50,000, bears to one-half of the adjusted basis of 
the business lease premises at the close of 1954, or $100,000. The 
percentage of rent which is business lease income for 1954 is, 
therefore, one-half (the ratio of $50,000 to $100,000) of $8,000, or 
$4,000, and this amount of $4,000 is considered an item of gross income 
derived from an unrelated trade or business.

    (c) Deductions--(1) Deductions allowable against gross income. The 
same percentage is used in determining both the portion of the rent and 
the portion of the deductions taken into account with respect to the 
business lease in computing unrelated business taxable income. Such 
percentage is applicable only to the sum of the following deductions 
allowable under section 161:
    (i) Taxes and other expenses paid or accrued during the taxable year 
upon or with respect to the real property subject to the business lease;
    (ii) Interest paid or accrued during the taxable year on the 
business lease indebtedness;
    (iii) A reasonable allowance for exhaustion, wear and tear 
(including a reasonable allowance for obsolescence) of the real property 
subject to such lease.


Where only a portion of the real property is subject to the business 
lease, there shall be taken into account only those amounts of the 
above-listed deductions which are properly allocable to the premises 
covered by such lease.
    (2) Excess deductions. The deductions allowable under subparagraph 
(1) of this paragraph with respect to a business lease are not limited 
by the amount included in gross income with respect to the rent from 
such lease. Any excess of such deductions over such gross income shall 
be applied against other items of gross income in computing unrelated 
business taxable income taxable under section 511(a).
    (3) Example. The application of this paragraph may be illustrated by 
the following example:

    Example. Assume the same facts as those in example 1 in paragraph 
(b)(3) of this section. Assume, also that for 1954 the organization pays 
taxes of $4,000 on the property, interest of $6,000 on its business 
lease indebtedness, and that the depreciation allowable for 1954 under 
section 167 is $10,000. Under the facts set forth in such example 1 and 
in this example, the deductions to be taken into account for 1954 in 
computing unrelated business taxable income would be two-fifths of the 
total of the deductions of $20,000, that is $8,000.

[T.D. 7229, 37 FR 28145, Dec. 21, 1972]



Sec. 1.514(b)-1  Definition of debt-financed property.

    (a) In general. For purposes of section 514 and the regulations 
thereunder, the term debt-financed property means any property which is 
held to produce income (e.g., rental real estate, tangible personal 
property, and corporate stock), and with respect to which there is an 
acquisition indebtedness (determined without regard to whether the 
property is debt-financed property) at any time during the taxable year. 
The term income is not limited to recurring income but applies as well 
to gains from the disposition of property. Consequently, when any 
property held to produce income by an organization which is not used in 
a manner described in section 514(b)(1) (A), (B), (C), or (D) is 
disposed of at a gain during the taxable year, and there was an 
acquisition indebtedness outstanding with respect to such property at 
any time during the 12-month period preceding the date of disposition 
(even though such period covers more than 1 taxable year), such property 
is debt-financed property. For example, assume that on June 1, 1972, an 
organization is given mortgaged, unimproved property which it does not 
use in a manner described in section 514(b)(1) (A), (B), (C), or (D) and 
that the organization assumes payment ofthe mortgage on such property. 
On July 15, 1972, the organization sells such property for a gain. Such 
property is debt-financed property and such gain is taxable as unrelated 
debt-financed income. See section 514(c) and Sec. 1.514(c)-1 for rules 
relating to when there is acquisition indebtedness with respect to 
property. See

[[Page 212]]

paragraph (a) of Sec. 1.514(a)-1 for rules determining the amount of 
income or gain from debt-financed property which is treated as unrelated 
debt-financed income.
    (b) Exceptions--(1) Property related to certain exempt purposes. (i) 
To the extent that the use of any property is substantially related 
(aside from the need of the organization for income or funds or the use 
it makes of the profits derived) to the exercise or performance by an 
organization of its charitable, educational, or other purpose or 
function constituting its basis for exemption under section 501 (or, in 
the case of an organization described in section 511(a)(2)(B), to the 
exercise or performance of any purpose or function designated in section 
501(c)(3)) such property shall not be treated as debt-financed property. 
See Sec. 1.513-1 for principles applicable in determining whether there 
is a substantial relationship to the exempt purpose of the organization.
    (ii) If substantially all of any property is used in a manner 
described in subdivision (i) of this subparagraph, such property shall 
not be treated as debt-financed property. In general the preceding 
sentence shall apply if 85 percent or more of the use of such property 
is devoted to the organization's exempt purpose. The extent to which 
property is used for a particular purpose shall be determined on the 
basis of all the facts and circumstances. These may include (where 
appropriate):
    (a) A comparison of the portion of time such property is used for 
exempt purposes with the total time such property is used,
    (b) A comparison of the portion of such property that is used for 
exempt purposes with the portion of such property that is used for all 
purposes, or
    (c) Both the comparisons described in (a) and (b) of this 
subdivision.
    (iii) This subparagraph may be illustrated by the following 
examples. For purposes of these examples it is assumed that the 
indebtedness is acquisition indebtedness.

    Example 1. W, an exempt organization, owns a computer with respect 
to which there is an outstanding principal indebtedness and which is 
used by W in the performance of its exempt purpose. W sells time for the 
use of the computer to M corporation on occasions when the computer is 
not in full-time use by W. W uses the computer in furtherance of its 
exempt purpose more than 85 percent of the time it is in use and M uses 
the computer less than 15 percent of the total operating time the 
computer is in use. In this situation, substantially all the use of the 
computer is related to the performance of W's exempt purpose. Therefore, 
no portion of the computer is treated as debt-financed property.
    Example 2. X, an exempt college, owns a four story office building 
which has been purchased with borrowed funds. In 1971, the lower two 
stories of the building are used to house computers which are used by X 
for administrative purposes. The top two stories are rented to the 
public for purposes not described in section 514(b)(1) (A), (B), (C), or 
(D). The gross income derived by X from the building is $6,000, all of 
which is attributable to the rents paid by tenants. There are $2,000 of 
expenses, allocable equally to each use of the building. The average 
adjusted basis of the building for1971 is $100,000, and the outstanding 
principal indebtedness throughout 1971 is $60,000. Thus, the average 
acquisition indebtedness for 1971 is $60,000. In accordance with 
subdivision (i) of this subparagraph, only the upper half of the 
building is debt-financed property. Consequently, only the rental income 
and the deductions directly connected with such income are to be taken 
into account in computing unrelated business taxable income. The portion 
of such amounts to be taken into account is determined by multiplying 
the $6,000 of rental income and $1,000 of deductions directly connected 
with such rental income by the debt/basis percentage. The debt/basis 
percentage is the ratio which the allocable part of the average 
acquisition indebtedness is of the allocable part of the average 
adjusted basis of the property, that is, the ratio which $30,000 (one-
half of $60,000) bears to $50,000 (one-half of $100,000). Thus, the 
debt/basis percentage for 1971 is 60 percent (the ratio of $30,000 to 
$50,000). Under these circumstances, X shall include net rental income 
of $3,000 in its unrelated business taxable income for 1971, computed as 
follows:

Total rental income.........................................      $6,000
Deductions directly connected with rental income............      $1,000
Debt/basis percentage ($30,000/$50,000).....................         60%
Rental income treated as gross income from an unrelated           $3,600
 trade or business (60 percent of $6,000)...................
Less the allowable portion of deductions directly connected         $600
 with such income (60 percent of $1,000)....................
                                                             -----------
Net rental income included by X in computing its unrelated        $3,000
 business taxable income pursuant to section 514............
                                                             ===========
 


[[Page 213]]

    Example 3. Assume the facts as stated in example 2 except that on 
December 31, 1971, X sells the building and realizes a long-term capital 
gain of $10,000. This is X's only capital transaction for 1971. An 
allocable portion of this gain is subject to tax. This amount is 
determined by multiplying the gain related to the nonexempt use, $5,000 
(one-half of $10,000), by the ratio which the debtedness for the 12-
month period preceding the date of sale, $30,000 (one-half of $60,000), 
is of the allocable part of the average adjusted basis, $50,000 (one-
half of $100,000). Thus, the debt/basis percentage with respect to 
computing the gain (or loss) derived from the sale of the building is 60 
percent (the ratio of $30,000 to $50,000). Consequently, $3,000 (60 
percent of $5,000) is a net section 1201 gain (capital gain net income 
for taxable years beginning after December 31, 1976). The portion of 
such gain which is taxable shall be determined in accordance with rules 
contained in subchapter P, chapter 1 of the Code (relating to capital 
gains and losses). See also section 511(d) and the regulations 
thereunder (relating to the minimum tax for tax preferences).

    (2) Property used in an unrelated trade or business--(i) In general. 
To the extent that the gross income from any property is treated as 
income from the conduct of an unrelated trade or business, such property 
shall not be treated as debt-financed property. However, any gain on the 
disposition of such property which is not included in the income of an 
unrelated trade or business by reason of section 512(b)(5) is includible 
as gross income derived from or on account of debt-financed property 
under paragraph (a)(1) of Sec. 1.514(a)-1.
    (ii) Amounts specifically taxable under other provisions of the 
Code. Section 514 does not apply to amounts which are otherwise included 
in the computation of unrelated business taxable income, such as rents 
from personal property includible pursuant to section 512(b)(13) or 
rents and interest from controlled organizations includible pursuant to 
section 512(b)(3). See paragraph (1)(5) of Sec. 1. 512(b)-1 for the 
rules determining the manner in which amounts are taken into account 
where such amounts may be included in the computation of unrelated 
business taxable income by operation of more than one provision of the 
Code.
    (3) Examples. Subparagraphs (1) and (2) of this paragraph may be 
illustrated by the following examples. For purposes of these examples it 
is assumed that the indebtedness is acquisition indebtedness.

    Example 1. X, an exempt scientific organization, owns a 10-story 
office building. During 1972, four stories are occupied by X's 
administrative offices, and the remaining six stories are rented to the 
public for purposes not described in section 514(b)(1) (A), (B), (C), or 
(D). On December 31, 1972, the building is sold and X realizes a long-
term capital gain of $100,000. This is X's only capital transaction for 
1972. The debt/basis percentage with respect to computing the gain (or 
loss) derived from the sale of the building is 30 percent. Since 40 
percent of the building was used for X's exempt purpose, only 60 percent 
of the building is debt-financed property. Thus, only $60,000 of the 
gain (60 percent of $100,000) is subject to this section. Consequently, 
the amount of gain treated as unrelated debt-financed income is $18,000 
($60,000 multiplied by the debt/basis percentage of 30 percent). The 
portion of such $18,000 which is taxable shall be determined in 
accordance with the rules contained in subchapter P, chapter 1 of the 
Code. See also section 511(d) and the regulations thereunder (relating 
to the minimum tax for tax preferences).
    Example 2. Y, an exempt organization, owns two properties, a 
restaurant and an office building. In 1972, all the space in the office 
building, except for the portion utilized by Y to house the 
administrative offices of the restaurant, is rented to the public for 
purposes not described in section 514(b)(1) (A), (B), (C), or (D). The 
average adjusted basis of the office building for 1972 is $2 million. 
The outstanding principal indebtedness throughout 1972 is $1 million. 
Thus, the highest acquisition indebtedness in the calendar year of 1972 
is $1 million. It is determined that 30 percent of the space in the 
office building is used for the administrative functions engaged in by 
the employees of the organization with respect to the restaurant. Since 
the income attributable to the restaurant is attributable to the conduct 
of an unrelated trade or business, only 70 percent of the building is 
treated as debt-financed property for purposes of determining the 
portion of the rental income which is unrelated debt-financed income. On 
December 31, 1972, the office building is sold and Y realizes a long-
term capital gain of $250,000. This is Y's only capital transaction for 
1972. In accordance with subparagraph (2)(i) of this paragraph, all the 
gain derived from this sale is taken into account in computing the 
amount of such gain subject to tax. The portion of such gain which is 
taxable is determined by multiplying the $250,000 gain by the debt/basis 
percentage. The debt/basis percentage is the ratio which the highest 
acquisition indebtedness for the 12-month period preceding the date of 
sale, $1 million, is of the

[[Page 214]]

averageadjusted basis, $2 million. Thus, the debt/basis percentage with 
respect to computing the gain (or loss) derived from the sale of the 
building is 50 percent (the ratio of $1 million to $2 million). 
Consequently, $125,000 (50 percent of $250,000) is a net section 1201 
gain (net capital gain for taxable years beginning after December 31, 
1976). The amount of such gain which is taxable shall be determined in 
accordance with the rules contained in subchapter P, chapter 1 of the 
Code. See also section 511(d) and the regulations thereunder.
    Example 3. (a) Z, an exempt university, owns all the stock of M, a 
nonexempt corporation. During 1971 M leases from Z University a factory 
unrelated to Z's exempt purpose and a dormitory for the students of Z, 
for a total annual rent of $100,000: $80,000 for the factory and $20,000 
for the dormitory. During 1971, M has $500,000 of taxable income, 
disregarding the rent paid to Z: $150,000 from the dormitory and 
$350,000 from the factory. The factory is subject to a mortgage of 
$150,000. Its average adjusted basis for 1971 is determined to be 
$300,000. Z's deductions for 1971 with respect to the leased property 
are $4,000 for the dormitory and $16,000 for the factory. In accordance 
with subdivision (ii) of this subparagraph, section 514 applies only to 
that portion of the rent which is excluded from the computation of 
unrelated business taxable income by operation of section 512(b)(3) and 
not included in such computation pursuant to section 512(b)(13). Since 
all the rent received by Z is derived from real property, section 
512(b)(3) would exclude all such rent from computation of Z's unrelated 
business taxable income. However, 70 percent of the rent paid to Z with 
respect to the factory and 70 percent of the deductions directly 
connected with such rent shall be taken into account by Z in determining 
its unrelated business taxable income pursuant to section 512(b)(15), 
computed as follows:

M's taxable income (disregarding rent paid to Z)............    $500,000
Less taxable income from dormitory..........................    $150,000
                                                             -----------
Excess taxable income.......................................    $350,000
Ratio ($350,000/$500,000)...................................      \7/10\
Total rent paid to Z........................................    $100,000
Total deductions ($4,000+$16,000)...........................     $20,000
Rental income treated under section 512(b)(15) as gross          $70,000
 income from an unrelated trade or business (\7/10\ of
 $100,000)..................................................
Less deductions directly connected with such income (\7/10\      $14,000
 of $20,000)................................................
                                                             -----------
Net rental income included by Z in computing its unrelated       $56,000
 business taxable income pursuant to section 512(b)(15).....
 

    (b) Since only that portion of the rent derived from the factory and 
the deductions directly connected with such rent not taken into account 
pursuant to section 512(b)(15) may be included in computing unrelated 
business taxable income by operation of section 514, only $10,000 
($80,000 minus $70,000) of rent and $2,000 ($16,000 minus $14,000) of 
deductions are so taken into account. The portion of such amounts to be 
taken into account is determined by multiplying the $10,000 of income 
and $2,000 of deductions by the debt/basis percentage. The debt/basis 
percentage is the ratio which the average acquisition indebtedness 
($150,000) is of the average adjusted basis of the property ($300,000). 
Thus, the debt/basis percentage for 1971 is 50 percent (the ratio of 
$150,000 to $300,000). Under these circumstances, Z shall include net 
rental income of $4,000 in its unrelated business taxable income for 
1971, computed as follows:

Total rents.................................................     $10,000
Deductions directly connected with such rents...............      $2,000
Debt/basis percentage ($150,000/$300,000)...................         50%
Rental income treated as gross income from an unrelated           $5,000
 trade or business (50 percent of $10,000)..................
Less the allowable portion of deductions directly connected       $1,000
 with such income (50 percent of $2,000)....................
Net rental income included by Z in computing its unrelated        $4,000
 business taxable income pursuant to section 514............
 

    (4) Property related to research activities. To the extent that the 
gross income from any property is derived from research activities 
excluded from the tax on unrelated business income by paragraph (7), 
(8), or (9) of section 512(b), such property shall not be treated as 
debt-financed property.
    (5) Property used in thrift shops, etc. To the extent that property 
is used in any trade or business which is excepted from the definition 
of unrelated trade or business by paragraph (1), (2), or (3) of section 
513(a), such property shall not be treated as debt-financed property.
    (6) Use by a related organization. For purposes of subparagraph (1), 
(4), or (5) of this paragraph, use of property by a related exempt 
organization (as defined in paragraph (c)(2)(ii) of this section) for a 
purpose described in such subparagraphs shall be taken into account in 
order to determine the extent to which such property is used for a 
purpose described in such subparagraphs.
    (c) Special rules--(1) Medical clinic. Property is not debt-financed 
property if it is real property subject to a lease to a medical clinic, 
and the lease is entered into primarily for purposes which are 
substantially related (aside from the need of such organization for 
income or funds or the use it makes of the rents derived) to the 
exercise or performance by the lessor of its charitable, educational, or 
other purpose or

[[Page 215]]

function constituting the basis for its exemption under section 501. For 
example, assume that an exempt hospital leases all of its clinic space 
to an unincorporated association of physicians and surgeons who, by the 
provisions of the lease, agree to provide all of the hospital's out-
patient medical and surgical services and to train all of the hospital's 
residents and interns. In this situation, the rents received by the 
hospital from this clinic are not to be treated as unrelated debt-
financed income.
    (2) Related exempt uses--(i) In general. Property owned by an exempt 
organization and used by a related exempt organization or by an exempt 
organization related to such related exempt organization shall not be 
treated as debt-financed property to the extent such property is used by 
either organization in furtherance of the purpose constituting the basis 
for its exemption under section 501. Furthermore, property shall not be 
treated as debt-financed property to the extent such property is used by 
a related exempt organization for a purpose described in paragraph 
(b)(4) or (5) of this section.
    (ii) Related organizations. For purposes of subdivision (i) of this 
subparagraph, an exempt organization is related to another exempt 
organization only if:
    (a) One organization is an exempt holding company described in 
section 501(c)(2) and the other organization receives the profits 
derived by such exempt holding company,
    (b) One organization has control of the other organization within 
the meaning of paragraph (1)(4) of Sec. 1.512(b)-1,
    (c) More than 50 percent of the members of one organization are 
members of the other organization, or
    (d) Each organization is a local organization which is directly 
affiliated with a common state, national, or international organization 
which is also exempt.
    (iii) Examples. This subparagraph may be illustrated by the 
following examples. For purposes of these examples it is assumed that 
the indebtedness is acquisition indebtedness.

    Example 1. M, an exempt trade association described in section 
501(c)(6), leases 70 percent of the space of an office building for 
furtherance of its exempt purpose. The title to such building is held by 
N, an exempt holding company described in section 501(c)(2), which 
acquired title to the building with borrowed funds. The other 30 percent 
of the space in this office building is leased to L, a nonstock exempt 
trade association described in section 501(c)(6). L uses such office 
space in furtherance of its exemptpurpose. The members of L's Board of 
Trustees serves for fixed terms and M's Board of Directors has the power 
to select all such members. N pays over to M all the profits it derives 
from the leasing of space in this building to M and L. Accordingly, M is 
related to N (as such term is defined in subdivision (ii)(a) of this 
subparagraph) and L is related to M (as such term is defined in 
subdivision (ii)(b) of this subparagraph). Under these circumstances, 
since all the available space in the building is leased to either an 
exempt organization related to the exempt organization holding title to 
the building or an exempt organization related to such related exempt 
organization, no portion of the building is treated as debt-financed 
property.
    Example 2. W, an exempt labor union described in section 501(c)(5), 
owns a 10-story office building which has been purchased with borrowed 
funds. Five floors of the building are used by W in furtherance of its 
exempt purpose. Four of the other floors are rented to X which is an 
exempt voluntary employees' beneficiary association described in section 
501(c)(9), operated for the benefit of W's members. X uses such office 
space in furtherance of its exempt purpose. Seventy percent of the 
members of W are also members of X. Accordingly, X is related to W (as 
such term is defined in subdivision (ii)(c) of this subparagraph). The 
remaining floor of the building is rented to the general public for 
purposes not described in section 514(b)(1) (A), (B), (C), or (D). Under 
thesecircumstances, no portion of this building is treated as debt-
financed property since more than 85 percent of the office space 
available in this building is used either by W or X, an exempt 
organization related to W, in furtherance of their respective exempt 
purpose. See paragraph (b)(1) of this section for rules relating to the 
use of property substantially related to an exempt purpose. See 
paragraph (b)(6) of this section for rules relating to uses by related 
exempt organizations.
    Example 3. Assume the same facts as in example 2, except that W and 
X are each exempt local labor unions described in section 501(c)(5) 
having no common membership and are each affiliated with N, an exempt 
international labor union described in section 501(c)(5). Under these 
circumstances, no portion of this building is treated as debt-financed 
property since more than 85 percent of the office space available in 
this building

[[Page 216]]

is used either by W or X, an exempt organization related to W, in 
furtherance of their respective exempt purpose.
    Example 4. Assume the same facts as in example 3, except that W and 
X are directly affiliated with different exempt international labor 
unions and that W and X are not otherwise affiliated with, or members 
of, a common exempt organization, other than an association of 
international labor unions. Under these circumstances, the portions of 
this building which are rented to X and to the general public are 
treated as debt-financed property since X is not related to W and W uses 
less than 85 percent of the building for its exempt purpose.

    (3) Life income contracts. (i) Property shall not be treated as 
debt-financed property when:
    (a) An individual transfers property to a trust or a fund subject to 
a contract providing that the income is to be paid to him or other 
individuals or both for a period of time not to exceed the life of such 
individual or individuals in a transaction in which the payments to the 
individual or individuals do not constitute the proceeds of a sale or 
exchange of the property so transferred, and
    (b) The remainder interest is payable to an exempt organization 
described in section 501(c)(3).
    (ii) Subdivision (i) of this subparagraph is illustrated by the 
following example.

    Example. On January 1, 1967, A transfers property to X, an exempt 
organization described in section 501(c)(3), which immediately places 
the property in a fund. On January 1, 1971, A transfers additional 
property to X, which property is also placed in the fund. In exchange 
for each transfer, A receives income participation fund certificates 
which entitle him to a proportionate part of the fund's income for his 
life and for the life of another individual. None of the payments made 
by X are treated by the recipients as the proceeds of a sale or exchange 
of the property transferred. In this situation, none of the property 
received by X from A is treated as debt-financed property.

    (d) Property acquired for prospective exempt use--(1) Neighborhood 
land--(i) In general. If an organization acquires real property for the 
principal purpose of using the land in the exercise or performance of 
its exempt purpose, commencing within 10 years of the time of 
acquisition, such property will not be treated as debt-financed 
property, so long as (a) such property is in the neighborhood of other 
property owned by the organization which is used in the performance of 
its exempt purpose, and (b) the organization does not abandon its intent 
to use the land in such a manner within the 10-year period. The rule 
expressed in this subdivision is hereinafter referred to as the 
neighborhood land rule.
    (ii) Neighborhood defined. Property shall be considered in the 
neighborhood of property owned and used by the organization in the 
performance of its exempt purpose if the acquired property is contiguous 
with the exempt purpose property or would be contiguous with such 
property except for the interposition of a road, street, railroad, 
stream, or similar property. If the acquired property is not contiguous 
with exempt function property, it may still be in the neighborhood of 
such property, but only if it is within 1 mile of such property and the 
facts and circumstances of the particular situation make the acquisition 
of contiguous property unreasonable. Some of the criteria to consider in 
determining this question include the availability of land and the 
intended future use of the land. For example, a university attempts to 
purchase land contiguous to its present campus but cannot do so because 
the owners either refuse to sell or ask unreasonable prices. The nearest 
land of sufficient size and utility is a block away from the campus. The 
university purchases such land. Under these circumstances, the 
contiguity requirement is unreasonable and the land purchased would be 
considered neighborhood land.
    (iii) Exception. The neighborhood land rule shall not apply to any 
property after the expiration of 10 years from the date of acquisition. 
Further, the neighborhood land rule shall apply after the first 5 years 
of the 10-year period only if the organization establishes to the 
satisfaction of the Commissioner that future use of the acquired land in 
furtherance of the organization's exempt purpose before the expiration 
of the 10-year period is reasonably certain. In order to satisfy the 
Commissioner, the organization does not necessarily have to show binding 
contracts. However, it must at least

[[Page 217]]

have a definite plan detailing a specific improvement and a completion 
date, and some affirmative action toward the fulfillment of such a plan. 
This information shall be forwarded to the Commissioner of Internal 
Revenue, Washington, DC 20224, for a ruling at least 90 days before the 
end of the fifth year after acquisition of the land.
    (2) Actual use. If the neighborhood land rule is inapplicable 
because:
    (i) The acquired land is not in the neighborhood of other property 
used by the organization in performance of its exempt purpose, or
    (ii) The organization (for the period after the first 5 years of the 
10-year period) is unable to establish to the satisfaction of the 
Commissioner that the use of the acquired land for its exempt purposes 
within the 10-year period is reasonably certain


but the land is actually used by the organization in furtherance of its 
exempt purpose within the 10-year period, such property (subject to the 
provisions of subparagraph (4) of this paragraph) shall not be treated 
as debt-financed property for any period prior to such conversion.
    (3) Limitations--(i) Demolition or removal required. (a) 
Subparagraphs (1) and (2) of this paragraph shall apply with respect to 
any structure on the land when acquired by the organization, or to the 
land occupied by the structure, only so long as the intended future use 
of the land in furtherance of the organization's exempt purpose requires 
that the structure be demolished or removed in order to use the land in 
such a manner. Thus, during the first 5 years after acquisition (and for 
subsequent years if there is a favorable ruling in accordance with 
subparagraph (1)(iii) of this paragraph) improved property is not debt-
financed so long as the organization does not abandon its intent to 
demolish the existing structures and use the land in furtherance of its 
exempt purpose. Furthermore, if there is an actual demolition of such 
structures, the use made of the land need not be the one originally 
intended. Therefore, the actual use requirement of this subdivision may 
be satisfied by using the land in any manner which furthers the exempt 
purpose of the organization.
    (b) Subdivision (i)(a) of this subparagraph may be illustrated by 
the following examples. For purposes of the following examples it is 
assumed that but for the application of the neighborhood land rule such 
property would be debt-financed property.

    Example 1. An exempt university acquires a contiguous tract of land 
on which there is an apartment building. The university intends to 
demolish the apartment building and build classrooms and does not 
abandon this intent during the first 4 years after acquisition. In the 
fifth year after acquisition it abandons the intent to demolish and 
sells the apartment building. Under these circumstances, such property 
is not debt-financed property for the first 4 years after acquisition 
even though there was no eventual demolition or use made of such land in 
furtherance of the university's exempt purpose. However, such property 
is debt-financed property as of the time in the fifth year that the 
intent to demolish the building is abandoned and any gain on the sale of 
property is subject to section 514.
    Example 2. Assume the facts as stated in Example 1 except that the 
university did not abandon its intent to demolish the existing building 
and construct a classroom building until the eighth year after 
acquisition when it sells the property. Assume further that the 
university did not receive a favorable ruling in accordance with 
subparagraph (1)(iii) of this paragraph. Under these circumstances, the 
building is debt- financed property for the sixth, seventh, and eighth 
years. It is not, however, treated as debt-financed property for the 
first 5 years after acquisition.
    Example 3. Assume the facts as stated in Example 2 except that the 
university received a favorable ruling in accordance with subparagraph 
(1)(iii) of this paragraph. Under these circumstances, the building is 
not debt-financed property for the first 7 years after acquisition. It 
only becomes debt-financed property as of the time in the eighth year 
when the university abandoned its intent to demolish the existing 
structure.
    Example 4. (1) Assume that a university acquires a contiguous tract 
of land containing an office building for the principal purpose of 
demolishing the office building and building a modern dormitory. Five 
years later the dormitory has not been constructed, and the university 
has failed to satisfy the Commissioner that the office building will be 
demolished and the land will be used in furtherance of its exempt 
purpose (and consequently has failed to obtain a favorable ruling under 
subparagraph (1)(iii) of this paragraph). In the ninth taxable year 
after acquisition the university converts the office building into

[[Page 218]]

an administration building. Under these circumstances, during the sixth, 
seventh, and eighth years after acquisition, the office building is 
treated as debt-financed property because the office building was not 
demolished or removed. Therefore, the income derived from such property 
during these years shall be subject to the tax on unrelated business 
income.
    (2) Assume that instead of converting the office building to an 
administration building, the university demolishes the office building 
in the ninth taxable year after acquisition and then constructs a new 
administration building. Under these circumstances, the land would not 
be considered debt-financed property for any period following the 
acquisition, and the university would be entitled to a refund of taxes 
paid on the income derived from such property for the sixth through 
eighth taxable years after the acquisition in accordance with 
subparagraph (4) of this paragraph.

    (ii) Subsequent construction. Subparagraphs (1) and (2) of this 
paragraph do not apply to structures erected on the land after the 
acquisition of the land.
    (iii) Property subject to business lease. Subparagraphs (1) and (2) 
of this paragraph do not apply to property subject to a lease which is a 
business lease (as defined in Sec. 1.514(f)-1) whether the organization 
acquired the property subject to the lease or whether it executed the 
lease subsequent to acquisition. If only a portion of the real property 
is subject to a lease, paragraph (c) of Sec. 1.514(f)-1 applies in 
determining whether such lease is a business lease.
    (4) Refund of taxes. (i) If an organization has not satisfied the 
actual use condition of subparagraph (2) of this paragraph or paragraph 
(e)(3) of this section before the date prescribed by law (including 
extensions) for filing the return for the taxable year, the tax for such 
year shall be computed without regard to the application of such actual 
use condition. However, if:
    (a) A credit or refund of any overpayment of taxes is allowable for 
a prior taxable year as a result of the satisfaction of such actual use 
condition, and
    (b) Such credit or refund is prevented by the operation of any law 
or rule of law (other than chapter 74, relating to closing agreements 
and compromises)


such credit or refund may nevertheless be allowed or made, if a claim is 
filed within 1 year after the close of the taxable year in which such 
actual use condition is satisfied. For a special rule with respect to 
the payment of interest at the rate of 4 percent per annum, see section 
514(b)(3)(D), prior to its amendment by section 7(b) of the Act of 
January 3, 1975 (Pub. L. 93-625, 88 Stat. 2115).
    (ii) This subparagraph may be illustrated by the following example. 
For purposes of this example it is assumed that but for the neighborhood 
land rule such property would be debt-financed property.

    Example. Y, a calendar year exempt organization, acquires real 
property in January 1970, which is contiguous with other property used 
by Y in furtherance of its exempt purpose. However, Y does not satisfy 
the Commissioner by January 1975, that the existing structure will be 
demolished and the land will be used in furtherance of its exempt 
purpose. In accordance with this subparagraph, from 1975 until the 
property is converted to an exempt use, the income derived from such 
property shall be subject to the tax on unrelated business income. 
During July 1979, Y demolishes the existing structure on the land and 
begins using the land in furtherance of its exempt purpose. At this time 
Y may file claims for refund for the open years 1976 through 1978. 
Further, in accordance with this subparagraph, Y may also file a claim 
for refund for 1975, even though a claim for such taxable year may be 
barred by the statute of limitations, provided such claim is filed 
before the close of 1980.

    (e) Churches--(1) In general. If a church or association or 
convention of churches acquires real property, for the principal purpose 
of using the land in the exercise or performance of its exempt purpose, 
commencing within 15 years of the time of acquisition, such property 
shall not be treated as debt-financed property so long as the 
organization does not abandon its intent to use the land in such a 
manner within the 15-year period.
    (2) Exception. This paragraph shall not apply to any property after 
the expiration of the 15-year period. Further, this paragraph shall 
apply after the first 5 years of the 15-year period only if the church 
or association or convention of churches establishes to the satisfaction 
of the Commissioner that use of the acquired land in furtherance of the 
organization's exempt purpose before the expiration of the 15-year 
period is reasonably certain. For purposes of the preceding sentence, 
the

[[Page 219]]

rules contained in paragraph (d)(1)(iii) of this section with respect to 
satisfying the Commissioner that the exempt organization intends to use 
the land within the prescribed time in furtherance of its exempt purpose 
shall apply.
    (3) Actual use. If the church or association or convention of 
churches for the period after the first 5 years of the 15-year period is 
unable to establish to the satisfaction of the Commissioner that the use 
of the acquired land for its exempt purpose within the 15-year period is 
reasonably certain, but such land is in fact converted to an exempt use 
within the 15-year period, the land (subject to the provisions of 
paragraph (d)(4) of this section) shall not be treated as debt-financed 
property for any period prior to such conversion.
    (4) Limitations. The limitations stated in paragraph (d)(3)(i) and 
(ii) of this section shall similarly apply to the rules contained in 
this paragraph.

[T.D. 7229, 37 FR 28146, Dec. 21, 1972; 39 FR 6607, Feb. 21, 1974, as 
amended by T.D. 7384, 40 FR 49322, Oct. 22, 1975; T.D. 7632, 44 FR 
42681, July 20, 1979; T.D. 7728, 45 FR 72651, Nov. 3, 1980]



Sec. 1.514(c)-1  Acquisition indebtedness.

    (a) In general--(1) Definition of acquisition indebtedness. For 
purposes of section 514 and the regulations thereunder, the term 
acquisition indebtedness means, with respect to any debt-financed 
property, the outstanding amount of:
    (i) The principal indebtedness incurred by the organization in 
acquiring or improving such property.
    (ii) The principal indebtedness incurred before the acquisition or 
improvement of such property if such indebtedness would not have been 
incurred but for such acquisition or improvement; and
    (iii) The principal indebtedness incurred after the acquisition or 
improvement of such property if such indebtedness would not have been 
incurred but for such acquisition or improvement and the incurrence of 
such indebtedness was reasonably foreseeable at the time of such 
acquisition or improvement


Whether the incurrence of an indebtedness is reasonably foreseeable 
depends upon the facts and circumstances of each situation. The fact 
that an organization did not actually foresee the need for the 
incurrence of an indebtedness prior to the acquisition or improvement 
does not necessarily mean that the subsequent incurrence of indebtedness 
was not reasonably foreseeable.
    (2) Examples. The application of subparagraph (1) of this paragraph 
may be illustrated by the following examples:

    Example 1. X, an exempt organization, pledges some of its investment 
securities with a bank for a loan and uses the proceeds of such loan to 
purchase an office building which it leases to the public for purposes 
other than those described in section 514(b)(1) (A), (B), (C), or (D). 
The outstanding principal indebtedness with respect to the loan 
constitutes acquisition indebtedness incurred prior to the acquisition 
which would not have been incurred but for such acquisition.
    Example 2. Y, an exempt scientific organization, mortgages its 
laboratory to replace working capital used in remodeling an office 
building which Y rents to an insurance company for purposes not 
described in section 514(b)(1) (A), (B), (C), or (D). The indebtedness 
is acquisition indebtedness since such indebtedness, though incurred 
subsequent to the improvement of the office building, would not have 
been incurred but for such improvement, and the indebtedness was 
reasonably foreseeable when, to make such improvement, Y reduced its 
working capital below the amount necessary to continue current 
operations.
    Example 3. (a) U, an exempt private preparatory school, as its sole 
educational facility owns a classroom building which no longer meets the 
needs of U's students. In 1971, U sells this building for $3 million to 
Y, a corporation which it does not control. U receives $1 million as a 
down payment from Y and takes back a purchase money mortgage of $2 
million which bears interest at 10 percent per annum. At the time U 
became the mortgagee of the $2 million purchase money mortgage, U 
realized that it would have to construct a new classroom building and 
knew that it would have to incur an indebtedness in the construction of 
the new classroom building. In 1972, U builds a new classroom building 
for a cost of $4 million. In connection with the construction of this 
building, U borrows $2.5 million from X Bank pursuant to a deed of trust 
bearing interest at 6 percent perannum. Under these circumstances, $2 
million of the $2.5 million borrowed to finance construction of the new 
classroom building would not have been borrowed but for the retention of 
the $2 million

[[Page 220]]

purchase money mortgage. Since such indebtedness was reasonably 
foreseeable, $2 million of the $2.5 million borrowed to finance the 
construction of the new classroom building is acquisition indebtedness 
with respect to the purchase money mortgage and the purchase money 
mortgage is debt-financed property.
    (b) In 1972, U receives $200,000 in interest from Y (10 percent of 
$2 million) and makes a $150,000 interest payment to X (6 percent of 
$2.5 million). In addition, assume that for 1972 the debt/basis 
percentage is 100 percent ($2 million/$2 million). Accordingly, all the 
interest and all the deductions directly connected with such interest 
income are to be taken into account in computing unrelated business 
taxable income. Thus, $200,000 of interest income and $120,000 
($150,000x$2 million/$2.5 million) of deductions directly connected with 
such interest income are taken into account. Under these circumstances, 
U shall include net interest income of $80,000 ($200,000 of income less 
$120,000 of deductions directly connected with such income) in its 
unrelated business taxable income for 1972.
    Example 4. In 1972 X, an exempt organization, forms a partnership 
with A and B. The partnership agreement provides that all three partners 
shall share equally in the profits of the partnership, shall each invest 
$3 million, and that X shall be a limited partner. X invests $1 million 
of its own funds in the partnership and $2 million of borrowed funds. 
The partnership purchases as its sole asset an office building which is 
leased to the general public for purposes other than those described in 
section 514(b)(1) (A), (B), (C), or (D). The office building cost the 
partnership $24 million of which $15 million is borrowed from Y bank. 
This loan is secured by a mortgage on the entire office building. By 
agreement with Y bank, X is held not to be personally liable for payment 
of such mortgage. By reason of section 702(b) the character of any item 
realized by the partnership and included in the partner's distributive 
share shall be determined as if the partner realized such item directly 
from the source from which it was realized by the partnership and in the 
same manner. Therefore, a portion of X's income from the building is 
debt-financed income. Under these circumstances, since both the $2 
million indebtedness incurred by X in acquiring its partnership interest 
and $5 million, the allocable portion of the partnership'sindebtedness 
incurred with respect to acquiring the office building which is 
attributable to X in computing the debt/basis percentage (one-third of 
$15 million), were incurred in acquiring income-producing property, X 
has acquisition indebtedness of $7 million ($2 million plus $5 million). 
Similarly, the allocable portion of the partnership's adjusted basis in 
the office building which is attributable to X in computing the debt-
basis percentage is $8 million (one-third of $24 million). Assuming no 
payment with respect to either indebtedness and no adjustments to basis 
in 1972, X's average acquisition indebtedness is $7 million and X's 
average adjusted basis is $8 million for such year. Therefore, X's debt/
basis percentage with respect to its share of the partnership income for 
1972 is 87.5 percent ($7 million/$8 million).

    (3) Changes in use of property. Since property used in a manner 
described in section 514(b)(1) (A), (B), (C), or (D) is not considered 
debt-financed property, indebtedness with respect to such property is 
not acquisition indebtedness. However, if an organization converts such 
property to a use which is not described in section 514(b)(1) (A), (B), 
(C), or (D) and such property is otherwise treated as debt-financed 
property, the outstanding principal indebtedness with respect to such 
property will thereafter be treated as acquisition indebtedness. For 
example, assume that in 1971 a university borrows funds to acquire an 
apartment building as housing for married students. In 1974 the 
university rents the apartment building to the public for purposes not 
described in section 514(b)(1) (A), (B), (C), or (D). The outstanding 
principal indebtedness is acquisition indebtedness as of the time in 
1974 when the building is first rented to the public.
    (4) Continued indebtedness. If:
    (i) An organization sells or exchanges property, subject to an 
indebtedness (incurred in a manner described in subparagraph (1) of this 
paragraph),
    (ii) Acquires another property without retiring the indebtedness, 
and
    (iii) The newly acquired property is otherwise treated as debt-
financed property


the outstanding principal indebtedness with respect to the acquired 
property is acquisition indebtedness, even though the original property 
was not debt-financed property. For example, to house its administrative 
offices, an exempt organization purchases a building with $600,000 of 
its own funds and $400,000 of borrowed funds secured by a pledge of its 
securities. It later sells the building for $1,000,000 without redeeming 
the pledge. It uses these proceeds to purchase an apartment building 
which it rents to the public for purposes not described in section 
514(b)(1) (A), (B), (C), or (D). The indebtedness of $400,000 is

[[Page 221]]

acquisition indebtedness with respect to the apartment building even 
though the office building was not debt-financed property.
    (5) Indebtedness incurred before June 28, 1966. For taxable years 
beginning before January 1, 1972, acquisition indebtedness does not 
include any indebtedness incurred before June 28, 1966, unless such 
indebtedness was incurred on rental real property subject to a business 
lease and such indebtedness constituted business lease indebtedness. 
Furthermore, in the case of a church or convention or association of 
churches, the preceding sentence applies without regard to whether the 
indebtedness incurred before June 28, 1966, constituted business lease 
indebtedness.
    (b) Property acquired subject to lien--(1) Mortgages. Except as 
provided in subparagraphs (3) and (4) of this paragraph, whenever 
property is acquired subject to a mortgage, the amount of the 
outstanding principal indebtedness secured by such mortgage is treated 
as acquisition indebtedness with respect to such property even though 
the organization did not assume or agree to pay such indebtedness. The 
preceding sentence applies whether property is acquired by purchase, 
gift, devise, bequest, or any other means. Thus, for example, assume 
that an exempt organization pays $50,000 for real property valued at 
$150,000 and subject to a $100,000 mortgage. The $100,000 of outstanding 
principal indebtedness is acquisition indebtedness just as though the 
organization had borrowed $100,000 to buy the property.
    (2) Other liens. For purposes of this paragraph, liens similar to 
mortgages shall be treated as mortgages. A lien is similar to a mortgage 
if title to property is encumbered by the lien for the benefit of a 
creditor. However, in the case where State law provides that a tax lien 
attaches to property prior to the time when such lien becomes due and 
payable, such lien shall not be treated as similar to a mortgage until 
after it has become due and payable and the organization has had an 
opportunity to pay such lien in accordance with State law. Liens similar 
to mortgages include (but are not limited to):

    (i) Deeds of trust,
    (ii) Conditional sales contracts,
    (iii) Chattel mortgages,
    (iv) Security interests under the Uniform Commercial Code,
    (v) Pledges,
    (vi) Agreements to hold title in escrow, and
    (vii) Tax liens (other than those described in the third sentence of 
this subparagraph).
    (3) Certain encumbered property acquired by gift, bequest or 
devise--(i) Bequest or devise. Where property subject to a mortgage is 
acquired by an organization by bequest or devise, the outstanding 
principal indebtedness secured by such mortgage is not to be treated as 
acquisition indebtedness during the 10-year period following the date of 
acquisition. For purposes of the preceding sentence, the date of 
acquisition is the date the organization receives the property.
    (ii) Gifts. If an organization acquires property by gift subject to 
a mortgage, the outstanding principal indebtedness secured by such 
mortgage shall not be treated as acquisition indebtedness during the 10-
year period following the date of such gift, so long as:
    (a) The mortgage was placed on the property more than 5 years before 
the date of the gift, and
    (b) The property was held by the donor for more than 5 years before 
the date of the gift


For purposes of the preceding sentence, the date of the gift is the date 
the organization receives the property.
    (iii) Limitation. Subdivisions (i) and (ii) of this subparagraph 
shall not apply if:
    (a) The organization assumes and agrees to pay all or any part of 
the indebtedness secured by the mortgage, or
    (b) The organization makes any payment for the equity owned by the 
decedent or the donor in the property (other than a payment pursuant to 
an annuity excluded from the definition of acquisition indebtedness by 
paragraph (e) of this section)


Whether an organization has assumed and agreed to pay all or any part of 
an indebtedness in order to acquire the property shall be determined by 
the facts and circumstances of each situation.

[[Page 222]]

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

    Example 1. A dies on January 1, 1971. His will devises an office 
building subject to a mortgage to U, an exempt organization described in 
section 501(c)(3). U does not at any time assume the mortgage. For the 
period 1971 through 1980, the outstanding principal indebtedness secured 
by the mortgage is not acquisition indebtedness. However, after December 
31, 1980, the outstanding principal indebtedness secured by the mortgage 
is acquisition indebtedness if the building is otherwise treated as 
debt-financed property.
    Example 2. Assume the facts as stated in example 1 except that on 
January 1, 1975, U assumes the mortgage. After January 1, 1975, the 
outstanding principal indebtedness secured by the mortgage is 
acquisition indebtedness if the building is otherwise treated as debt-
financed property.

    (4) Bargain sale before October 9, 1969. Where property subject to a 
mortgage is acquired by an organization before October 9, 1969, the 
outstanding principal indebtedness secured by such mortgage is not to be 
treated as acquisition indebtedness during the 10-year period following 
the date of acquisition if:
    (i) The mortgage was placed on the property more than 5 years before 
the purchase, and
    (ii) The organization paid the seller a total amount no greater than 
the amount of the seller's cost (including attorney's fees) directly 
related to the transfer of such property to the organization, but in any 
event no more than 10 percent of the value of the seller's equity in the 
property transferred.
    (c) Extension of obligations--(1) In general. An extension, renewal, 
or refinancing of an obligation evidencing a preexisting indebtedness is 
considered as a continuation of the old indebtedness to the extent the 
outstanding principal amount thereof is not increased. Where the 
principal amount of the modified obligation exceeds the outstanding 
principal amount of the preexisting indebtedness, the excess shall be 
treated as a separate indebtedness for purposes of section 514 and the 
regulations thereunder. For example, if the interest rate on an 
obligation incurred prior to June 28, 1966, by an exempt university is 
modified subsequent to such date, the modified obligation shall be 
deemed to have been incurred prior to June 28, 1966. Thus, such an 
indebtedness will not be treated as acquisition indebtedness for taxable 
years beginning before January 1, 1972, unless the original indebtedness 
was business lease indebtedness (as defined in Sec. 1.514(g)-1).
    (2) Extension or renewal. In general, any modification or 
substitution of the terms of an obligation by the organization shall be 
an extension or renewal of the original obligation, rather than the 
creation of a new indebtedness to the extent that the outstanding 
principal amount of the indebtedness is not increased. The following are 
examples of acts which result in the extension or renewal of an 
obligation:
    (i) Substitution of liens to secure the obligation;
    (ii) Substitution of obligees, whether or not with the consent of 
the organization;
    (iii) Renewal, extension or acceleration of the payment terms of the 
obligation; and
    (iv) Addition, deletion, or substitution of sureties or other 
primary or secondary obligors.
    (3) Allocation. In cases where the outstanding principal amount of 
the modified obligation exceeds the outstanding principal amount of the 
unmodified obligation and only a portion of such refinanced indebtedness 
is to be treated as acquisition indebtedness, payments on the amount of 
the refinanced indebtedness shall be apportioned prorata between the 
amount of the preexisting indebtedness and the excess amount. For 
example, assume that an organization has an outstanding principal 
indebtedness of $500,000 which is treated as acquisition indebtedness. 
It borrows another $100,000, which is not acquisition indebtedness, from 
the same lending institution and gives the lender a $600,000 note for 
its total obligation. In this situation, a payment of $60,000 on the 
amount of the total obligation would reduce the acquisition indebtedness 
by $50,000 and the excess indebtedness by $10,000.
    (d) Indebtedness incurred in performing exempt purpose. Acquisition 
indebtedness does not include the incurrence of an

[[Page 223]]

indebtedness inherent in the performance or exercise of the purpose or 
function constituting the basis of the organization's exemption. Thus, 
acquisition indebtedness does not include the indebtedness incurred by 
an exempt credit union in accepting deposits from its members or the 
obligation incurred by an exempt organization in accepting payments from 
its members to provide such members with insurance, retirement or other 
similar benefits.
    (e) Annuities--(1) Requirements. The obligation to make payment of 
an annuity is not acquisition indebtedness if the annuity meets all the 
following requirements:
    (i) It must be the sole consideration (other than a mortgage to 
which paragraph (b)(3) of this section applies) issued in exchange for 
the property acquired;
    (ii) At the time of the exchange, the present value of the annuity 
(determined in accordance with subparagraph (2) of this paragraph) must 
be less than 90 percent of the value of the prior owner's equity in the 
property received in the exchange;
    (iii) The annuity must be payable over the life of one individual in 
being at the time the annuity is issued, or over the lives of two 
individuals in being at such time; and
    (iv) The annuity must be payable under a contract which:
    (a) Does not guarantee a minimum number of payments or specify a 
maximum number of payments, and
    (b) Does not provide for any adjustment of the amount