While the IRS hasn’t come out with new or changed regulations around administrative expense treated as qualifying distributions, it did release new guidance January 11, 2017. The guidance addresses whether there are limits on the amount of administrative expenses that can be treated as qualifying distributions to meet the minimum requirements of IRC Section 4942.
As a reminder, qualifying distributions under Section 4942(g) include:
- Direct expenditures to accomplish a religious, charitable, scientific, literary, educational, or other permitted public purpose under IRC 170(c)(1) or (2)(B)
- Certain set-asides for future charitable purchases or expenditures
- Grants to public charities or private operating foundations
- Expenses not attributable to charitable purposes don’t qualify as distributions. For example, payment of excise taxes under Chapter 42 doesn’t qualify.
- Limits on administrative expenses. Neither the Internal Revenue Code nor the Treasury Regulations currently sets limits on the amount of administrative expenses that are eligible for qualifying distribution treatment. However, they must be reasonable and necessary for the completion of the private foundation’s objective. In Rev. Rul. 75-945, the legal fees of a private foundation were determined to be reasonable and necessary for exempt purposes.
- Administrative expenses can be direct or indirect. Direct expenses are specifically identified with a particular activity, including compensation and travel expenses of employees and officers. Indirect, known as overhead expenses, aren’t specifically identifiable with a particular activity. Examples include most occupancy expenses, clerical compensation, repairs, equipment rental and maintenance, accounting fees, and personnel serving the department or function.
- Reasonable and necessary expenses may sometimes be improperly allocated between revenue and expenses, net investment income, and disbursements for charitable purposes. If you generate unrelated business income, consider allocating direct and indirect expenses to that activity category as well.
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If you’d like more information about guidance on qualifying distributions, contact your Moss Adams professional.