Private foundations (PFs) remain popular because wealthy donors often want to maintain control over donated assets. In a similar vein, many wealthy families form family offices to provide greater control and oversight over their financial affairs. More substantial family offices typically provide investment management oversight to various family members, trusts and other entities established by the family. As such, it's natural for these family offices to consider extending investment management services to the family's PF.

Family advisors are often reluctant to structure an investment management relationship between the family office and the family's PF, particularly if the family office is providing these services (and potentially other administrative services) to the PF for compensation. The concern typically expressed is that the Internal Revenue Service could challenge the relationship as inappropriate and subject the PF to punitive excise taxes or loss of tax-exempt status. Even worse, if such a challenge were made public, the local community could misinterpret it, creating negative publicity for the family.

As a result, it's not uncommon for a family office to decline to serve the family's PF, or to provide such services to the PF for no compensation. However, neither of those approaches may be particularly desirable. If services aren't provided, the PF loses the investment expertise and oversight of the family office. If services are provided for no compensation, then the other “clients” of the family office disproportionately bear this time and expense allocation.

Although a family may need to address a number of issues before its family office provides services to its PFs, we'll focus on one significant issue — compensation, including how to structure a compensation arrangement between the family office and PF to mitigate punitive excise taxes. We'll review the relevant rulings in this area and suggest leading practices that may assist a family in supporting such an arrangement before the IRS.

Provision of Services

Wealthy families often establish family offices to oversee the family's personal and financial matters.1 Services provided may include investment management and financial reporting, day-to-day accounting, tax assistance, bill paying and real estate management. The scope of services provided typically is based upon the needs of the family clients, the portfolio of assets they hold and the appetite of the family office owners to provide such services. Whether such responsibilities are outsourced to third-party providers or performed in-house is based on the office's desired level of control over the service, the relative expertise of the office employees and, most importantly, the cost to the family office.

Once the scope of services is determined, the annual capital outlay required to run the family office operation can be established. Although the owners (typically the senior generation) can fund this outlay annually through periodic capital contributions, it's often better to allow the family office to charge its clients for the use of these services. These family office clients may include other family members, family entities such as family partnerships and trusts, and yes, the family's PF.2

Excise Tax Regime

PFs have been a primary philanthropic vehicle for wealthy families for decades. A PF is a legal entity, typically formed as either a corporation or trust and established by an individual or family with a principal purpose of benefiting unrelated charitable organizations or institutions to further scientific, educational, cultural, social, religious or other charitable objectives.

The main advantage of a PF over a public charity is that the donor, together with individuals whom the donor selects, can directly control and carry out the PF's activities for the benefit of the public charities that it supports. Family donors typically contribute cash, marketable securities and other assets to the PF and receive an immediate income tax charitable deduction. Assuming the PF has applied for and received tax-exempt status, its only tax obligation is typically a 2 percent excise tax each year on its annual net investment income (reduced to 1 percent if certain distribution requirements are met). Each year, the PF must make an annual distribution to public charities equal to at least 5 percent of the fair market value (FMV) of the PF's non-charitable-use assets.

The main disadvantage of a PF, beyond the additional administration involved, is the stringent set of rules that accompany its operation. In the past, PFs were criticized as a tool to protect the private interests of the wealthy rather than a means to carry out stated charitable objectives. In response, the federal tax law imposed a punitive excise tax framework in an effort to discourage perceived abuses.

The PF excise tax regime includes punitive taxes on: (1) acts of self-dealing,3 (2) failure to distribute income,4 (3) excess business holdings,5 (4) investments that jeopardize the PF's charitable purpose,6 and (5) certain prohibited expenditures.7 Although an appreciation and understanding of all of these taxes is necessary and important to properly administer a PF, we'll only focus on the excise tax for acts of self-dealing. This tax is imposed upon certain transactions between a PF and an individual closely related to the PF (that is, a disqualified person). The other excise taxes are beyond the scope of this article.

Acts of Self-Dealing

In basic terms, acts of self-dealing can include any direct (or indirect) financial transaction between the PF and a disqualified person. Such transactions include: (1) the sale, exchange or lease of property, (2) lending of money, (3) furnishing of goods, services or facilities, (4) payment of compensation, (5) transfer to a disqualified person of the income of assets of a PF, and (6) an agreement by a PF to make a payment to a government official.8

Disqualified persons with respect to a PF include: (1) substantial contributors to the PF, (2) PF managers, (3) an owner of more than 20 percent of the total combined voting power of a corporation, the profits interest of a partnership or the beneficial interest of a trust or unincorporated enterprise that's a substantial contributor to the PF, and (4) a member of the family of any of the above individuals.9 Related entities of disqualified persons are also disqualified, including: (1) a corporation in which any of the above individuals own more than 35 percent of the total combined voting power, (2) a partnership in which any of the above individuals own more than 35 percent of the profits interest, and (3) a trust or estate in which any of the above individuals holds more than 35 percent of the beneficial interest.10

The penalties for a self-dealing violation are significant, imposing on the disqualified person a 10 percent tax on the amount involved in the transaction for each year (or part thereof) during which the transaction occurred.11 In addition, in any case in which a PF manager knowingly participates in the act of self-dealing, a 5 percent tax on the amount involved is levied on the manager, unless his participation isn't willful and is due to reasonable cause.12 Even further, in cases in which the act of self-dealing isn't corrected within the taxable period, the disqualified person must pay a tax equal to 200 percent of the amount involved.13

If a wealthy family forms a PF and funds a family office, those family members and their family office likely are disqualified persons with regard to any transactions between the PF and the family office. Accordingly, it would appear that the excise tax rule on self-dealing specifically prohibits payment of compensation by a PF to a family office. So, without further analysis, an investment management arrangement between the family office and the PF would appear to be an act of self-dealing.

Reasonable Compensation

There is, however, an exception to the self-dealing restriction on payment of compensation by the PF to a disqualified person. If the exception is met, the taxpayer avoids exposure to the punitive self-dealing excise taxes. Payment of compensation won't be considered an act of self-dealing if: (1) the payment is made for personal services that are reasonable and necessary to carrying out the PF's exempt purpose, and (2) the compensation isn't excessive.14

The Treasury regulations discuss this exception and provide an example that's particularly helpful in this context.15 In this example, a PF manager owns an investment counseling business. Acting in his capacity as investment counselor, he manages the PF's investment portfolio and, in return, receives an amount that's determined not to be excessive under Treas. Regs. Section 1.162-7 (discussed later). His interaction with the PF doesn't constitute an act of self-dealing, as it meets the criteria for the exception in the Internal Revenue Code regarding personal services.16

The regulation makes it clear that the exception to self-dealing applies regardless of whether the person who receives the compensation is an individual.17 Thus, the logic of the example extends to the family office. The regulation cross-references Treas. Regs. Section 1.162-7 for the determination of whether compensation is excessive. As expected, Treas. Regs. Section 1.162-7 doesn't specifically define excessive compensation. Instead, it states the common-sense principle that reasonable compensation is, in general, what would ordinarily be paid for like services by like enterprises under like circumstances.18

Despite the lack of specificity, the transaction at issue appears to be statutorily excluded from treatment as an act of self-dealing, provided that it's properly implemented. Effectively, a family office can provide investment management and other personal services to family's PF, so long as the compensation paid is reasonable.

Scope of Other Personal Services

Based on the above example in the Treasury regulations, investment management services are eligible for the exception for personal services. In addition, guidance provided in the IRS Manual states that the services of an accountant would generally be deemed to meet the exception.19 But what other personal services may be performed pursuant to the exception from self-dealing?

In the past, the IRS has issued favorable private letter rulings to a fairly broad range of services performed for PFs. For instance, in PLR 9238027 (June 22, 1992), a newly formed family office proposed to provide a variety of personal services for two PFs, including accounting, bookkeeping, asset management, tax services, investment services, secretarial services, administration of grant-making programs, services related to preservation and display of assets held for charitable use and services as a liaison with outside advisors, such as legal counsel, estate planners, tax and accounting advisors and banks.

PLR 9703031 (Oct. 22, 1996) involved proposed services including asset management (for example, review of and advice regarding asset allocation, including selection and monitoring of investment managers), coordination of tax matters (for example, recordkeeping, preparation of returns and tax planning), other financial services (for example, cash management, accounting, accounts payable, financial analysis and investment appraisals) and administrative assistance in charitable programs.

The exact scope of the personal services exception to self-dealing has been complicated by the Tax Court's 1997 opinion in Madden v. Commissioner.20 In that case, a PF that operated a museum contracted with a disqualified company for janitorial and related services. The IRS argued that these services failed to qualify for the personal services exception to self-dealing. The Tax Court reviewed the legislative history of the self-dealing rules and stated that any exceptions to those rules should be construed narrowly. The Tax Court noted that the examples of “personal services” in the Treasury regulations include legal services, investment management services and general banking services. Those services, which the court described as “essentially professional and managerial in nature,” were viewed as distinguishable from the janitorial and related services at issue. Based upon this perceived difference and the narrow construction of the exceptions to the self-dealing rules, the court ruled that the services in question didn't constitute “personal services,” resulting in the imposition of self-dealing tax.

Following Madden, some PLR requests appear to have curtailed the range of proposed services. For example, in PLRs 200217056 (Jan. 30, 2002) and 200238053 (June 24, 2002), the services at issue were specifically defined to exclude secretarial services.

Nevertheless, taxpayers still have received favorable rulings for a wide variety of managerial services. In PLRs 200228026 (April 16, 2002) and 200228028 (April 16, 2002) the proposed services included: (1) strategic portfolio planning, investment counsel and asset allocation; (2) analysis, purchase and sale of securities; (3) selection, supervision and oversight of investment managers that are unrelated third parties; (4) selection, supervision and oversight of property management services (for example, janitorial and maintenance) provided by unrelated third parties; (5) selection, supervision and monitoring of legal, tax and accounting services provided by unrelated third parties; (6) selection, supervision and monitoring of other management and administrative services provided by third parties; (7) bookkeeping and accounting services; and (8) cash flow planning. Note that in this case, consistent with the finding in Madden, the family office's role involved the supervision of property maintenance services of third parties as opposed to the performance of those services.

Proper Structuring

Some PLRs have provided a framework for structuring a proper investment management and/or personal services arrangement between a family office and a PF. (For an overview of these PLRs, see “Framework for Structuring," p. 38.) These PLRs reveal that the leading practices for structuring such an arrangement include: (1) establishing an objective compensation methodology, (2) applying it regularly and continuously, and (3) supporting it through contemporaneous documentation.

  1. Objective methodology

    Taxpayers have typically taken one of two distinct approaches when designing the compensation arrangement:

    Cost recovery arrangements — Several families requested rulings on arrangements that determine compensation on a cost recovery basis. In PLR 9238027 (June 22, 1992), a newly formed family office proposed to provide a variety of personal services for two PFs. Employees of a disqualified person had previously provided these services to the PFs at no charge. The taxpayer proposed to have the family office charge the PFs on a cost recovery basis in accordance with the actual time spent by family office employees. The taxpayer represented that if the PFs were to purchase the services on their own, the costs would exceed what would be paid to the family office. Based upon the taxpayer's representations, the arrangement was determined not to be an act of self-dealing.

    PLR 9703031 (Oct. 22, 1996) also involved PFs that had been receiving services from related parties without charge. The taxpayer proposed that the family office provide personal services to the PFs based on an allocated, fully absorbed cost recovery basis, in accordance with time spent by the employees of the office and actual charges (with no mark-up) from outside service providers. The taxpayer represented that the fees would be below commercial institutions' current charges for comparable services, not excessive and in conformance with Treas. Regs. Section 1.162-7. The IRS ruled that the services were necessary in the performance of the PFs' tax-exempt purposes. Based on the taxpayer's representation that the compensation would be reasonable, the IRS also ruled that the proposed arrangement wouldn't be an act of self-dealing.

    Market-based arrangements — Although no investment management or personal services arrangement should exceed the amount charged for similar services by third-party providers, an arrangement designed at FMV appears to meet the definition of reasonable compensation under Treas. Regs. Section 1.162-7(b)(3) (that is, what would ordinarily be paid for like services by like enterprises under like circumstances). Thus, some PLRs proposed a methodology to determine the market rate for the arrangement and supported the arrangement with corroborating, third-party evidence.

    In PLRs 9702036, 9702037 and 9702038 (all issued Oct. 16, 1996), for example, the PF determined that standard practice in the financial management industry where the PF was located was to charge 50 to 75 basis points of asset market value, and it obtained and presented to the IRS fee schedules from several area banks and trust companies to this effect. The family office chose to charge an annual fee based on only 20 to 30 basis points of asset market value — a significant discount off the market rate. The IRS determined that the arrangement wouldn't be an act of self-dealing.

    In PLR 9626007 (March 25, 1996), the IRS issued a favorable ruling regarding a proposed arrangement in which the family office would charge fees for bookkeeping, accounting and tax return services not to exceed the lower of at least two bona fide proposals solicited from reputable firms for the same services.

    In PLR 200303061 (Oct. 21, 2002), the family proposed to acquire more price quotes, with the charity obtaining, on an annual basis, fee schedules from at least three independent companies that provided professional investment consulting services comparable to the services performed by the family office. The office would average the fee schedules from each company and apply the average schedule rate to the FMV of the PF's portfolio to determine its fees. The IRS ruled that this arrangement wouldn't be an act of self-dealing.

    PLR 200607028 (Nov. 21, 2005) simply stated that the PF was familiar with fees money managers charged and that the family-controlled bank would survey other institutions at least annually to determine that its fees are competitive. The IRS ruled that the proposed investment arrangement (for compensation that's not excessive) qualified for the exception to self-dealing.

    PLRs 200228026 (April 16, 2002) and 200228028 (April 16, 2002) involved a successful proposal that the fees would be calculated in various ways, but would never exceed the range of fees ordinarily charged by commercial institutions for comparable services in the geographic area in which such services were performed.

    PLR 9425004 (March 14, 1994) featured a newly formed corporation that would become trustee or (co-trustee) of two split-interest trusts. In its role, the entity would provide necessary trust management services to assist in accomplishing the trusts' exempt purposes, including services related to the administration of the trusts' grant-making process. The entity would charge its clients a fee and use a portion of this fee to compensate outside advisors, including investment counselors, accountants, attorneys, banks and insurance agents and to pay for any services that it subcontracted with third parties. The taxpayer represented that the total fee paid by the trusts wouldn't materially exceed the amount previously paid for trust company services and the services rendered by its outside advisors. In addition, the fee charged by the entity wouldn't exceed the going rate in the community for the types of services covered by the fee. Based on the taxpayer's representation that the compensation was reasonable, necessary and not excessive, the IRS ruled that the proposed arrangement wouldn't constitute an act of self-dealing.

    PLR 200238053 (June 24, 2002) featured a cost recovery arrangement coupled with a market-based safeguard. Specifically, the family office proposed hiring an independent consultant with experience in employee benefits matters to review service agreements with the family office and the salary of each family office employee. This method is supported by the Tax Court's commentary in its ruling in International Capital Holding Corp. and Subsidiaries v. Commissioner21 (to be discussed later). In that case, the Tax Court looked favorably upon a disinterested party determining compensation to ensure reasonableness.

    Family offices pursuing a market-based arrangement may wish to consider using third-party data to support their determination. One such source is the Council on Foundations (the Council), a national non-profit membership association.22 The Council regularly surveys independent, family, community and private foundations concerning, among other items, their administrative expenses and fiscal oversight. As part of its Foundation Management Series, the Council releases an Administrative and Investment Expenses Report with mean, percentile and sample size data on investment consulting fees of PFs reported by asset level.23 Although compensation arrangements should be tailored to specific family circumstances, the report may provide helpful, third-party data for purposes of supporting a reasonable compensation position.24

  2. Regular and continuous application

    In attempting to qualify for the personal services exception to self-dealing, even a very well-conceived compensation arrangement is diminished in value if it isn't implemented carefully. A family seeking to demonstrate the reasonableness of a compensation arrangement between a PF and family office should effectuate that arrangement in as businesslike a manner as possible. This will require that compensation be paid at regular intervals and in well-defined amounts. After all, unrelated investment managers would insist on regular, well-defined payments as a condition for providing their services.

    The PLRs in this context offer detailed examples of how the amount and timing of payments has been determined. One such example is the arrangement in PLR 200303061 (Oct. 21, 2002):

    On an annual basis, [the private foundation] will obtain fee schedules from at least three independent companies who provide professional investment advisory services that are comparable to the services provided by [the family office]. The industry practice is to calculate fees based upon the fair market value of portfolio assets under management. [The private foundation] will average the fees schedules from each of the surveyed investment advisory companies and apply the average schedule rate to the fair market value of [the private foundation's] investment portfolio managed by [the family office]. The fair market value of the investment portfolio will be valued at the end of each quarter and the average schedule rate will be divided by four. The resulting fees will be paid quarterly in arrears. In the event of a significant contribution or distribution, the value of the investment portfolio will be the average daily balance for the quarter. A significant contribution or distribution is defined as an amount equal to x percent or more of the investment portfolio valued as of the end of the previous quarter.

    In contrast, payments that are ill-defined in amount or made sporadically could, if viewed in the most negative light, prompt a third party to question whether such amounts were, in fact, for personal services rendered.

  3. Contemporaneous documentation

    However compensation is determined, the family office and PF should memorialize the methodology in a contract prior to the beginning of the arrangement. To the extent possible, disinterested parties (that is, non-family members or independent counsel) should negotiate compensation. The contract should clearly delineate the duties to be performed by the family office for the PF, complete with time periods over which such duties are to be performed. If both investment management services and other personal services are contemplated, it's typical for each to be included in a separate contract as the rights and obligations of the contracting parties, as well as the compensation methodology, are distinctly different.

    Once the arrangement begins, the services should be documented as they're performed. For example, in certain personal service arrangements, using timesheets to record the amount of allocable time put forth by family office personnel in providing the service or tracking a reasonable sample period and extrapolating the results, will help to substantiate the reasonableness of the related compensation paid.

    Case law has illustrated the importance of the above factors in sustaining the desired tax treatment of compensation arrangements between related taxpayers. In International Capital Holding Corp., the Tax Court allowed deductions for compensation paid among commonly owned corporations partly because: 1) disinterested parties negotiated the payments using normal procedures for determining officer compensation, and (2) the taxpayers were able to substantiate services performed on numerous projects, including the involvement of senior-level personnel.25

What Didn't Work

One Tax Court case is a good example of the practices families should avoid. In Kermit Fischer Foundation v. Comm'r, the Tax Court found that compensation paid to a PF manager-trustee was excessive. The self-dealing excise tax was imposed against the trustee for amounts received in excess of the determined amount of reasonable compensation.26 While an extreme case, the Tax Court's opinion provides some insight into the practices that PFs and family offices should avoid.

Compensation excessive relative to asset size and amount of charitable contributions

In Kermit Fischer, the trustee's compensation greatly exceeded the customary amount paid to trustees of PFs during the period at issue. An expert witness testified that the customary percentage charged was 40 to 50 basis points of the PF's assets, plus 5 percent of the PF's income. The trustee's compensation calculated using this market rate methodology should have been $1,450 to $2,000 each year, but in this case averaged $38,633 per year.

The court also noted the very low amount of charitable contributions paid by the PF during the years in question. For two of the years together, charitable contributions totaled only $1,725. In light of this observation, family offices and PFs may also want to consider both the size of the PF's assets and the amount of yearly charitable contributions in evaluating the reasonableness of the compensation.

Compensation paid sporadically, in irregular amounts

Moreover, compensation payments in Fischer were sporadic, paid anywhere from two days to two weeks apart. The amounts paid were also irregular and appeared to depend on the trustee's financial condition at the time. The parties should document compensation amounts to be paid and the intervals over which they're to be paid in contracts before services are performed.

No evidence of services performed

Neither the PF nor the trustee documented the work the trustee purportedly performed on behalf of the PF. As discussed above, it's vitally important that the agreed-upon services are laid out in a contract before the engagement begins. The services should also be documented as they're performed.

Additional Observations

From a review of the rulings and through application of these concepts in practice, we can make a number of other observations related to these arrangements:

Other family-related charitable entities

Although we've focused on structuring arrangements with PFs, the exclusion from self-dealing for personal services can be applied to arrangements between the family office and other family charitable entities, such as a charitable lead trust or charitable remainder trust.27

Related excise tax rulings

Families and their advisors may find it helpful that certain PLRs noted that the respective arrangement not only qualified for the exclusion from self-dealing, but also didn't constitute a taxable expenditure under IRC Section 4945,28 nor did it constitute an impermissible private inurement or benefit that would adversely affect the PF's tax-exempt status.29

Transitioning from no-charge arrangements

In some cases, certain family offices may decide to move from an existing no-charge arrangement to a new for-compensation arrangement for services provided to the PF. Based upon multiple PLRs, such a transition should be permissible. Specifically, the IRS has issued favorable rulings to taxpayers switching from no-charge arrangements to cost recovery arrangements,30 below-market fees based upon a percentage of assets31 and market-based fees not to exceed ordinary fees charged by commercial institutions.32

State fiduciary law

Although not the subject of any of the rulings, families contemplating these arrangements should be careful to comply with any state fiduciary laws regarding self-dealing.33

Additional self-dealing situations

As mentioned earlier, the family may need to address a number of issues before its family office provides services to its PF. Other issues may include the sharing of office space between a family office and PF or co-investment arrangements between the family's PFs and other family entities. We strongly recommend engaging competent advisors to assist in addressing these issues.

Moving Forward

Although this article reviewed relevant rulings and outlined suggested leading practices for families contemplating such arrangements, families seeking a greater level of assurance on a proposed arrangement may consider requesting their own PLRs from the IRS.

Unfortunately, any such PLR can't provide absolute assurance against a self-dealing assertion because the determination of what's reasonable compensation in this context is a question of fact,34 and the IRS ordinarily won't issue PLRs on matters in which the determination requested is primarily one of fact.35 As such, the favorable PLRs in this area often state that the transaction won't be an act of self-dealing as long as the taxpayer's representation of reasonable compensation is accurate.

Nevertheless, applying for a PLR shows cautiousness, good faith and transparency on the part of the taxpayer. If a good faith effort is made to quantify reasonable compensation, it would appear inequitable for the IRS to assert an excise tax against a family that has adhered faithfully to the fact pattern it presented in a successful PLR request. In the absence of a PLR request, structuring an arrangement consistent with the leading practices derived from relevant PLRs may be the best alternative.

The authors would like to acknowledge Emily A. Stojak of the Chicago office of Deloitte Tax LLP for her contributions to this article.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates and related entities, shall not be responsible for any loss sustained by any person who relies on this publication.

Endnotes

  1. For a more comprehensive article on structuring family offices, see Eric L. Johnson, “Current Leading Practices for Structuring the Family Office,” The Tax Adviser (October 2011) at p. 678.
  2. Family offices providing investment management services should be aware that on June 22, 2011, the Securities and Exchange Commission (SEC) issued their final rule on the definition of “family offices” for purposes of qualifying for an exemption from registration with the SEC. Although application of the final rule to this arrangement is beyond the scope of this article, a family office providing investment management services to the family's private foundation (PF) is a permissible arrangement in the final rule under the right facts and circumstances. For details on the SEC's final rule, see “SEC Rules on the Family Office” by Miles C. Padgett, Trusts & Estates (September 2011) at p. 38. SEC counsel should be consulted prior to entering into any such arrangement.
  3. Internal Revenue Code Section 4941.
  4. IRC Section 4942.
  5. IRC Section 4943.
  6. IRC Section 4944.
  7. IRC Section 4945.
  8. IRC Section 4941(d)(1).
  9. IRC Section 4946(a)(1).
  10. Ibid.
  11. IRC Section 4941(a)(1).
  12. IRC Section 4941(a)(2).
  13. IRC Section 4941(b)(1).
  14. IRC Section 4941(d)(2)(E).
  15. Treasury Regulations Section 53.4941(d)-3(c)(1).
  16. Treas. Regs. Section 53.4941(d)-3(c)(2) Ex. 2.
  17. Treas. Regs. Section 53.4941(d)-3(c)(1).
  18. Treas. Regs. Section 1.162-7(b)(3).
  19. Internal Revenue Service Manual Section 7.27.15.4.1.4(3)(B) (04-26-1999).
  20. Madden v. Commissioner, T.C. Memo. 1997-395; see also Brian W. Crozier, “Maddening Uncertainty on the Scope of the Personal Service Exception to Foundation Self-Dealing,” Taxation of Exempts (May/June 2003) at p. 251.
  21. International Capital Holding Corp. and Subsidiaries v. Comm'r, T.C. Memo. 2002-109.
  22. The authors have no affiliation with this organization.
  23. The full report is available for purchase at www.cof.org/store.
  24. In Private Letter Ruling 9008001 (Oct. 24, 1989), the Internal Revenue Service referred to the Foundation Management Report published by the Council on Foundations and the Corporate Directors' Compensation Guide by the Conference Board, Inc., in determining the reasonableness of compensation paid to directors of a PF.
  25. International Capital Holding Corp., supra note 21.
  26. Kermit Fischer Foundation v. Comm'r, T.C. Memo. 1990-300.
  27. IRC Section 4947.
  28. PLR 9626007 (March 25, 1996).
  29. PLR 9703031 (Oct. 22, 1996).
  30. PLR 9238027 (June 22, 1992).
  31. PLR 9702036 (Oct. 16, 1996).
  32. PLRs 200228026, 200228028 (both issued April 16, 2002).
  33. See, e.g., Kathryn W. Miree, “The Rules of Engagement: Managing Liability for Nonprofit Boards,” 38 University of Miami Institute on Estate Planning 1101 (2004).
  34. RTS Investment Corp. v. Comm'r, 877 F.2d 647, 650 (8th Cir. 1989).
  35. Revenue Procedure 2011-3, 2011-1 I.R.B. 111, Section 4.02(1).

Eric L. Johnson, far left, is a partner in the Chicago office of Deloitte Tax LLP and serves as the national competency leader for Deloitte's estate, gift, trust and charitable competency group. Ryan E. Thomas is a senior manager in the Chicago office of Deloitte Tax LLP

Framework for Structuring

These private letter rulings suggest leading practices for setting up an arrangement between a private foundation and a family office

Private letter ruling Date issued Arrangement Other details
9238027 June 22, 1992 Services performed at cost basis for less than the amount that would be charged by third parties. Family office is a newly formed corporation, the stock of which is owned by a disqualified person.
9425004 March 14, 1994 Newly formed corporation owned by disqualified persons invests assets of private foundation and performs investment advisory and custodial services. Total fee wouldn't materially exceed the amount previously paid for trust company services and services rendered by outside advisors. The fee charged wouldn't exceed the going rate in the community. Family office is a corporation, owned by the grandchildren of the foundation's grantor.
9626007 March 25, 1996 Cost of services doesn't exceed the lower of at least two bona fide proposals solicited from reputable firms (the ruling concerns bookkeeping, accounting and tax return services). Family office is a corporation, owned by the foundation's grantors and their children.
9702036
9702037
9702038
Oct. 16, 1996 Related rulings. Annual fee based on 20 to 30 basis points of market value of assets (customary charge was 50 to 75 basis points). Family office is a corporation, the only clients of which are members of a single family and related entities. The family office appears to be family owned.
9703031 Oct. 22, 1996 Fees based on an allocated, fully absorbed cost recovery basis in accordance with actual time spent by personnel; below amount charged by commercial institutions. Family office is a closely held corporation.
200228026
200228028
April 16, 2002 Apparently related rulings. Fees calculated in various ways, including a percentage of the value of assets managed; not to exceed the range of fees ordinarily charged by commercial institutions. Family office is a corporation owned by income beneficiary/trustee of the net income charitable remainder unitrust (NIMCRUT) and services are provided to the NIMCRUT and limited liability company owned by the NIMCRUT.
200238053 June 24, 2002 Allocable share through cost-sharing service agreement, including engagement of independent consultant with experience in employee benefits and human resources to ensure that fees charged are reasonable. Management company owned by the grantor of foundation will provide services.
200303061 Oct. 21, 2002 Average fees from three surveyed investment advisory firms; apply average schedule rate to fair market value of investment portfolio managed by family office. Grantor of the charitable trust is also the sole proprietor of the family office, which will provide services to the trust.
200607028 Nov. 21, 2005 Survey other institutions at least annually to determine that fees are competitive. Bank indirectly owned in full by foundation; the grantor will provide services to the foundation.

Eric L. Johnson & Ryan E. Thomas