Foundation may set aside funds for charter school

Plain-English summary

A private foundation planned to construct and operate a tuition-free public charter school serving kindergarten through sixth grade, with a possible later expansion. The approval, planning, permitting, and construction process would require multiple professionals and could not be completed within one year. The foundation requested a set-aside to preserve capital for the major construction costs while paying smaller preliminary expenses. The IRS approved the set-aside under Section 4942(g)(2), provided the amount is paid within 60 months after the first set-aside.

Ruling snapshot

• Question: May the foundation treat funds reserved for a multi-year public charter school project as a qualifying distribution?
• Outcome: Approved: the set-aside must be paid within 60 months after the first set-aside.
• Key authorities: IRC §§ 170(c)(2)(B) and 4942(g)(2); Treas. Reg. § 53.4942(a)-3(b); Rev. Rul. 74-450

Full text (IRS public release)

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

Date: January 23, 2021
Number: 202116018
Release Date: 4/23/2021

Employer Identification Number:

Contact Person - ID Number:

Contact Telephone Number:

LEGEND
C = Name of Organization
D = Name of Public-School Board
m = Amount

UIL
4942.03-07

Dear

Why you are receiving this letter

This is our response to your December 31, 2019 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 requesting a set-aside as described in Internal Revenue Code Section
4942(g)(2) for the purpose of constructing and operating a public charter school.
The public charter school will provide elementary school education to the general
public at no direct cost to the families of students. The facilities that will be used for
the charter school are expected to cost approximately m dollars to construct and
take less than sixty (60) months to complete.

The public charter school will be named C. Initially, C will provide education for
students who are in kindergarten through sixth grade and may potentially expand
to provide seventh and eighth grade education in the future. You have hired a
consulting firm that has extensive experience in helping not-for-profit organizations
design, establish and operate charter schools, and is proceeding based upon the

recommendations of such consultants and communications with D and other
individuals and organizations that are expected to be involved in this project.

You are currently working with various legal advisors, and experts that focus in
obtaining government approval for charter schools, in order to obtain approval
from D to open and operate a charter school at your planned location. You intend
to commence operations for the [redacted] school year. In the event that the
project cannot be completed in time to commence operation for the [redacted]
school year, the charter school is expected to be operational for the [redacted]
school year.

The approval process for the operation of the public charter school followed by the
construction of the school facilities will take more than a year to complete and is
better served by way of a set-aside rather than the immediate payment of funds.

The initial expenses associated with the approval of the new charter school will be
legal and advisory fees associated with the application to D for approval to open a
charter elementary school, employee related expenses for certain employees who
will be assisting with such application and planning, and for expenses relating to
the initial stages of building an elementary school facility. The expenses leading up
to the construction of the school building are expected to be minimal in
comparison to the cost of constructing the school building.

The building of an elementary school facility will require engineers, architects,
contractors, professional consultants, and other professionals for the study of the
subject property, surveying, analysis, planning, obtaining applicable governmental
permits, and otherwise proceeding as required to commence construction of the
school facility. These expenses will also be minimal in comparison to the actual
construction costs of the school, and a set-aside would help you to preserve
capital to cover expenses associated with the construction of the school.

These initial planning items could take up to eighteen (18) months, because there
will be a coordinated effort on behalf of a number of various professionals to
ensure that the proper governmental approvals are obtained, and that approval is
received from D. Unfortunately, timing in relation to obtaining governmental
permits cannot readily be determined. It is clear that an application to open a
charter school that is legally sufficient must eventually be approved by D, but there
may be a period of deliberation and coordination between you and D, based upon
the desired operation of the school, when the school will open, and how many
students the school will accept.

Additionally, once all required permits have been obtained, the design for the
school facilities have been finalized and approved, and the application to open the
charter school has been approved, construction can commence on the school
facilities. Due to the size and scope of the project, it would not be possible to
obtain all of the necessary approvals and complete construction of the facilities

within one (1) year. For this reason, a set-aside will better facilitate the
construction and administrative procedures required to complete the project.

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: Notice 437