Private foundation may set aside funds to recruit and train a charter school leader

Plain-English summary

A private foundation that funds education initiatives (pre-K through 12 schooling, charter school formation, teacher and leadership development, and after-school programs) asked the IRS to approve a "set-aside" of funds under Internal Revenue Code § 4942(g)(2). Private foundations normally must pay out a minimum amount each year, but they can instead reserve money for a specific multiyear project and still have it count as a qualifying distribution if the project is better accomplished with a set-aside than an immediate payment. Here the foundation contracted with an organization to recruit nationally and train a fellow to found and lead a new charter school in a particular city. The recruitment is highly competitive and takes time, and the foundation must commit the funds now so a qualified candidate will leave their current job for the fellowship, even though payments are made only as milestones are met over several years. The IRS approved the set-aside because it is a long-term project requiring more than one year's income to ensure continuity. The foundation must pay out the set-aside amount within 60 months of the first set-aside, record it as a pledge or obligation, and account for it under the minimum-investment-return and adjusted-net-income rules.

Ruling snapshot

• Question: May the private foundation treat funds reserved to recruit and train a charter school leader as a qualifying distribution via a set-aside under § 4942(g)(2)?
• Outcome: Approved, subject to payment within the required 60-month period.
• Key authorities: IRC §§ 4942(g)(2), 4942(e)(1)(A), 4942(f); Treas. Reg. § 53.4942(a)-3(b); Rev. Rul. 74-450

Full text (IRS public release)

Scanned document; transcription proofread from the IRS OCR text. Obvious OCR misreads were corrected, redacted identifiers, years, and amounts are marked [redacted], and wording is otherwise verbatim.

Internal Revenue Service                         Department of the Treasury
P.O. Box 2508
Cincinnati, OH 45201

                                                 Employer Identification Number:
                                                 [redacted]
Number: 201843017                                Contact Person - ID Number:
Release Date: 10/26/2018                         [redacted]
                                                 Contact Telephone Number:
                                                 [redacted]
Date: July 31, 2018

LEGEND                                           UIL: 4942.03-07

B = City

C = Contractor

v dollars = Amount of total set-aside
w dollars = Amount of total set-aside
x dollars = Amount of total set-aside

Dear [redacted]:

Why you are receiving this letter

This is our response to your March 6, 2017 letter requesting approval of a set-
aside under Internal Revenue Code Section 4942(g)(2). You've been recognized
as tax-exempt under Section 501(c)(3) of the Code and have been determined to
be a private foundation under Section 509(a).

Our determination

Based on the information furnished, your set-aside program is approved under
Internal Revenue Code Section 4942(g)(2). As required under Section 4942(g)(2),
the set aside amount must be paid within the 60-month period after the date of the
first set-aside.

Description of set-aside request

You are recognized as an organization described in section 501(c)(3) of the Code
as a nonprofit trust, and are classified as a private foundation within the meaning
of section 509(a). Your objectives are funding education initiatives such as
education for students in grades pre-K through 12 grades, charter school
formation, teacher development, educational leadership development, after school
education, and education studies in the B area.

You have requested a ruling regarding a proposed set-aside of funds in the
amount of v dollars (consisting of an initial set aside of w dollars for the taxable
year ending in [redacted] and an additional set-aside of x dollars for the taxable year
ending in [redacted]) in connection with your contract with C to recruit and train a
charter school leader.

The specific project is the fulfilment of the contract, which specifies that C will
identify one qualified individual and train him/her through the C Fellowship to open
an outstanding charter school in B, which will conform to the established C
principles of school design. C was originally to have identified and engaged this
Fellow for the [redacted] Fellowship to design, found, and lead a charter school
for opening in the [redacted] school year. The contract further provides that, should C
be unable to identify a qualified person within the timeframe dictated by a
school opening, C would work to identify and engage a Fellow to join the [redacted]
Fellowship to open the charter school in the [redacted] school year.

In addition to the core fellowship training and charter application support, C will
also provide a slate of follow-on support services to the leader of the B school
once it opens. You will provide funding totaling v dollars for facilities and a post-
authorization start-up grant.

The recruitment of a suitable person for the fellowship takes much care and effort.
The program is competitive and very few are selected. C recruits nationally for
Fellows and expends much time and exertion on your behalf to sign a highly
qualified young person to lead your school. Furthermore, it is essential that C
fellows align with C's approach, which is based on stringent principles of school
design.

Despite rigorous recruitment efforts, no fellow was signed for [redacted]. Consequently,
C will strive to recruit a Fellow to open a charter school in the [redacted] school year.

The project is better accomplished through a set-aside than through the immediate
payment of funds because, on the one hand, you must commit the funds now for
the search, placement and education of the fellow, even though the first
disbursements of the dedicated funds do not take place until [redacted]. Fellows need
to know in advance that they are being supported by the sponsor. Many leave their
current jobs to take on the fellowship and the commitment must be binding for
them to take such a risk and move forward. On the other hand, prepaying the
contract will not accelerate the process and you will make payments to C only as
certain milestones are met.

You submit that the v dollars set-aside will be paid out within 5 years of the date of
the first set-aside. The set-aside amount is expected to be disbursed according to
the following timeline. From January to June [redacted], C will conduct intensive
recruiting for a fellow. August: The Fellowship orientation. September through
August [redacted]: Training, Board recruitment, planning, charter application and
approval, etc.

Basis for our determination

Internal Revenue Code Section 4942(g)(2)(A) states that an amount set aside for
a specific project, which includes one or more purposes described in Section
170(c)(2)(B), may be treated as a qualifying distribution if it meets the
requirements of Section 4942(g)(2)(B).

Section 4942(g)(2)(B) of the Code states that an amount set aside for a specific
project will meet the requirements of this subparagraph if, at the time of the set-
aside, the foundation establishes that the amount will be paid within five years and
either clause (i) or (ii) are satisfied.

Section 4942(g)(2)(B)(i) of the Code is satisfied if, at the time of the set-aside, the
private foundation establishes that the project can better be accomplished using
the set-aside than by making an immediate payment.

Section 53.4942(a)-3(b)(1) of the Foundations and Similar Excise Taxes
Regulations provides that a private foundation may establish a project as better
accomplished by a set-aside than by immediate payment if the set-aside satisfies
the suitability test described in Section 53.4942(a)-3(b)(2).

Section 53.4942(a)-3(b)(2) of the Foundations and Similar Excise Taxes
Regulations provides that specific projects better accomplished using a set-aside
include, but are not limited to, projects where relatively long-term expenditures
must be made requiring more than one year's income to assure their continuity.

In Revenue Ruling 74-450, 1974-2 C.B. 388, an operating foundation converted a
portion of newly acquired land into a public park under a four-year construction
contract. The construction contract payments were to be made mainly during the
final two years. This constituted a "specific project." The foundation's set-aside of
all its excess earnings for four years was treated as a qualifying distribution under
Internal Revenue Code Section 4942(g)(2).

What you must do

Your approved set-aside(s) will be documented on your records as pledges or
obligations to be paid by the date specified. The amounts set aside will be taken
into account to determine your minimum investment return under Internal Revenue
Code Section 4942(e)(1)(A), and the income attributable to your set aside(s) will
also be taken into account in computing your adjusted net income under Section
4942(f) of the Code.

Additional information

This determination is directed only to the organization that requested it. Internal
Revenue Code Section 6110(k)(3) provides that it may not be used or cited as a
precedent.

Please keep a copy of this letter in your records.

If you have any questions, please contact the person listed in the heading of this
letter.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosure