Section 508(e) of the Internal Revenue Code requires every private foundation’s governing instrument to contain specific, irrevocable provisions that commit the foundation to distributing its income each year and to avoiding four categories of prohibited conduct under Chapter 42. Without that language, the foundation is not entitled to tax exemption under Section 501(a).1Office of the Law Revision Counsel. 26 U.S. Code 508 – Special Rules With Respect to Section 501(c)(3) Organizations Get the language into the articles of incorporation or trust agreement before filing for exempt recognition. Fixing it later means amending the organizing document, and that adds delay and cost.
The Five Provisions the Instrument Must Contain
Section 508(e) is not satisfied by a board policy, a mission statement, or a promise to follow the law. The text of the organizing document itself must include provisions whose effect is to:
- Require the foundation to distribute its income for each tax year at a time and in a manner that avoids the tax on undistributed income under Section 4942.
- Prohibit the foundation from engaging in any act of self-dealing under Section 4941.
- Prohibit the foundation from retaining any excess business holdings under Section 4943.
- Prohibit the foundation from making any investments that would jeopardize its charitable purposes under Section 4944.
- Prohibit the foundation from making any taxable expenditures under Section 4945.
All five must appear, and the restrictions must be irrevocable under the terms of the document.2Internal Revenue Service. Rev. Rul. 2024-10 – Governing Instruments
What Counts as the Governing Instrument
The governing instrument is whatever document brought the foundation into existence. For a nonprofit corporation, that is the articles of incorporation or charter. For a charitable trust, it is the trust agreement or declaration of trust. For an unincorporated association, it is the articles of association. Bylaws are not a substitute. The 508(e) language belongs in the instrument that legally forms the entity, because that is the document Congress required the foundation to be bound by.
Who the Requirement Applies To
Every organization recognized under Section 501(c)(3) is classified either as a public charity or a private foundation, and the default is private foundation. An organization escapes private foundation status only by qualifying as a public charity under one of the exceptions in Section 509(a).3Internal Revenue Service. EO Operational Requirements: Private Foundations and Public Charities If it cannot, Section 508(e) applies automatically.
Public charities are not subject to 508(e). Neither are churches and their integrated auxiliaries, supporting organizations described in Section 509(a)(3), or public safety testing organizations described in Section 509(a)(4), all of which are excluded from private foundation status by statute.4Bloomberg Tax. 26 U.S.C. 509 – Private Foundation Defined Churches are also outside the Section 508(a) and (b) notification requirements entirely.5Office of the Law Revision Counsel. 26 USC 508 – Special Rules With Respect to Section 501(c)(3) Organizations
When State Law Satisfies Section 508(e)
Many states have enacted statutes that impose the Chapter 42 restrictions on private foundations formed within the state. Under IRS regulations, a foundation’s governing instrument is treated as meeting the 508(e) requirements if valid state law either requires the foundation to comply with the Chapter 42 rules or deems those required provisions to be part of the governing instrument.2Internal Revenue Service. Rev. Rul. 2024-10 – Governing Instruments
Revenue Ruling 75-38 identified states that had enacted qualifying legislation as of 1975, a list that included Alabama, Alaska, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, and Maine, among others.6Internal Revenue Service. Revenue Ruling 75-38 – Private Foundations; Governing Instruments; State Laws Enacted Several of those state statutes contain opt-out mechanisms, which means a foundation can exclude itself from the deemed compliance by putting a contrary provision in its governing instrument or getting a court order.
Even where state law technically covers the requirement, the safer practice is to include the explicit 508(e) provisions in the instrument itself. That removes any question during the Form 1023 review and closes off arguments about whether a particular state’s version fully matches the federal standard.
What the Instrument Is Binding the Foundation To
The purpose of the 508(e) language is to make the foundation’s exempt status contingent on its being legally committed to the operational rules of Chapter 42. A brief look at what those five rules actually forbid explains why the language matters.
Annual Income Distribution (Section 4942)
Private foundations must distribute a minimum amount for charitable purposes each year. The baseline is 5% of the fair market value of the foundation’s non-charitable-use assets, less any acquisition debt on those assets, and this is called the minimum investment return.7Office of the Law Revision Counsel. 26 U.S. Code 4942 – Taxes on Failure to Distribute Income Qualifying distributions include grants to public charities, direct charitable activities, and reasonable administrative costs tied to those activities. The foundation has until the end of the following tax year to distribute the required amount. Anything still undistributed after that triggers an initial excise tax of 30% on the shortfall, rising to 100% if the amount stays undistributed through the close of the taxable period.
Self-Dealing (Section 4941)
Section 4941 flatly prohibits transactions between the foundation and its disqualified persons, whether or not the terms favor the foundation. There is no arm’s-length defense. Sales, leases, loans, and the furnishing of goods, services, or facilities between the foundation and a disqualified person are all covered, as is any use of foundation income or assets by a disqualified person.8Internal Revenue Service. Self-Dealing by Private Foundations: Use of Foundations Income or Assets
Disqualified persons include substantial contributors, foundation managers (officers, directors, trustees), owners of more than 20% of a substantial contributor entity, and family members of any of those individuals, along with entities in which those insiders hold more than 35%.9Office of the Law Revision Counsel. 26 U.S. Code 4946 – Definitions and Special Rules Family covers spouses, ancestors, children, grandchildren, great-grandchildren, and the spouses of those descendants.
One narrow exception allows the foundation to pay reasonable, non-excessive compensation to a disqualified person for personal services necessary to carry out the exempt purpose.10Internal Revenue Service. IRC Section 4941(d)(2)(E) – Taxes on Self-Dealing, Special Rules The initial tax on the disqualified person is 10% of the amount involved per year the transaction is uncorrected; the additional tax for failure to correct within the taxable period is 200%.11Office of the Law Revision Counsel. 26 USC 4941 – Taxes on Self-Dealing
Excess Business Holdings (Section 4943)
The foundation and all disqualified persons combined generally cannot own more than 20% of the voting stock of any business enterprise. Where an unrelated third party has effective control, the ceiling rises to 35%. The same limits apply to partnerships and other unincorporated enterprises.12Office of the Law Revision Counsel. 26 U.S. Code 4943 – Taxes on Excess Business Holdings A de minimis rule treats holdings of no more than 2% of voting stock and 2% in value as not excess.13Internal Revenue Service. IRC Section 4943: Taxes on Excess Business Holdings A foundation that receives excess holdings by gift or bequest has five years to dispose of them before the tax applies.14eCFR. 26 CFR 53.4943-6 – Five-Year Period to Dispose of Gifts, Bequests The initial tax is 10% of the excess; the additional tax for failure to divest is 200%.15Internal Revenue Service. Taxes on Excess Business Holdings
Jeopardizing Investments (Section 4944)
Foundation managers cannot invest assets in ways that jeopardize the foundation’s ability to carry out its exempt purpose. The IRS applies a prudent-person standard, asking whether the managers used ordinary business care in making the investment. The initial tax is 10% of the jeopardizing investment for each year it remains in jeopardy, with a matching 10% on any manager who knowingly approved it. If the investment is not removed from jeopardy within the taxable period, the additional tax on the foundation is 25%.16Internal Revenue Service. Taxes on Jeopardizing Investments
Taxable Expenditures (Section 4945)
Taxable expenditures are payments that fall outside the foundation’s charitable mission. The statute reaches spending to influence legislation; spending to influence public elections or fund voter registration drives (with narrow exceptions for nonpartisan drives); grants to individuals for travel, study, or similar purposes made without IRS pre-approval of the selection procedures; and grants to organizations that are not public charities unless the foundation exercises expenditure responsibility.17Office of the Law Revision Counsel. 26 U.S. Code 4945 – Taxes on Taxable Expenditures
Expenditure responsibility means conducting a pre-grant inquiry, obtaining written reports from the grantee on how the funds were used, and reporting to the IRS.18Internal Revenue Service. IRC Section 4945(h) – Expenditure Responsibility Individual grant programs require pre-approved selection criteria that are objective, nondiscriminatory, and serve a charitable class broad enough to constitute a public purpose.19Internal Revenue Service. IRC Section 4945(g) Individual Grants The initial tax on the foundation is 20% of each taxable expenditure and the additional tax is 100%.
The Consequence of Missing or Deficient Language
Section 508(e) is written as a condition of exemption. A private foundation that does not include the required provisions in its governing instrument, and that is not covered by a qualifying state statute, is not entitled to exemption under Section 501(a).1Office of the Law Revision Counsel. 26 U.S. Code 508 – Special Rules With Respect to Section 501(c)(3) Organizations That is separate from the Chapter 42 excise taxes, which continue to apply on their own terms whenever a foundation actually engages in the prohibited conduct. The instrument language is what commits the foundation, in writing, to the operational rules; the excise taxes are what enforces those rules once conduct crosses the line. Both matter, and 508(e) is the piece that has to be right on day one.