Section 507: Overview, definition, and example
What is Section 507?
Section 507 refers to a provision in the Internal Revenue Code (IRC) that deals with the termination of the tax-exempt status of private foundations. It provides guidelines for how a private foundation can terminate its status as a tax-exempt organization under Section 501(c)(3) of the IRC. This section primarily addresses the tax consequences and the required actions when a private foundation decides to end its operations or ceases to be a private foundation.
Why is Section 507 important?
Section 507 is important because it sets forth the rules and penalties for private foundations that choose to terminate their status. This ensures that foundations that have benefited from tax-exempt status are held accountable for any tax benefits they received. Section 507 also establishes the conditions under which private foundations can distribute their remaining assets before they terminate their status and ensures proper oversight of such terminations.
For foundations and nonprofits, understanding the provisions of Section 507 helps them manage their tax-exempt status properly and avoid unexpected tax liabilities if they decide to cease operations.
Understanding Section 507 through an example
Imagine a private foundation that has been operating for several years and providing grants to educational institutions. The foundation’s board of directors decides to terminate the organization. According to Section 507, the foundation must:
- Pay a termination tax: Section 507(c) requires that the foundation pay a tax on its net assets at the time of termination. The tax is calculated based on the lesser of the aggregate tax benefit it received from its tax-exempt status or the net value of its assets when it ceases to operate as a private foundation.
- Distribute its remaining assets: The foundation must follow specific rules regarding how it distributes its assets to avoid penalties or issues with the IRS.
For example, if the foundation had $500,000 in net assets at the time of termination, and it received $200,000 in tax benefits during its years of operation, it would need to pay the lesser of these two amounts as the termination tax.
An example of Section 507 clause
Here’s how a Section 507 clause might appear in a contract or agreement:
“In the event that the Foundation ceases to operate as a private foundation under Section 501(c)(3) of the Internal Revenue Code, the Foundation shall comply with the requirements set forth in Section 507 of the IRC, including the payment of any termination tax and proper distribution of remaining assets.”
Conclusion
Section 507 is a key provision in the Internal Revenue Code that governs the termination of private foundation status. It ensures that foundations that choose to end their operations do so in a manner that complies with IRS regulations, including the payment of any necessary taxes on their net assets.
For private foundations, understanding Section 507 is critical to properly manage the termination process and avoid penalties or issues related to the termination of tax-exempt status.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.