A 501c3 (charity) purchases a modified endowment life insurance contract and
later decides to take a distribution from the contract (borrows
against the cash value).
Is the distribution from the modified endowment contract free from
income tax AND penalty tax due to the charity's tax-exempt status?

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Request for Question Clarification by jbf777-ga on 30 Dec 2003 21:41 PST

Hello -

Thanks for your question.

Just so I understand you correctly, what you are looking to do is
borrow a certain amount against the cash value and loan it to the
*corporation*, not an individual, correct?

jbf

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Clarification of Question by torodbull-ga on 30 Dec 2003 23:44 PST

Hello jbf.
The charity owns the MEC and wishes to borrow against the cash value
to pay off a debt. This does not cause unrelated business income tax
(UBIT).
Because it has a tax exempt status, will the distribution be income
tax free and penalty tax free?
Please don't hesitate to ask additional questions.
Thanks

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Request for Question Clarification by jbf777-ga on 31 Dec 2003 07:34 PST

Thanks for the clarification.  Can you tell me what state you're in?

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Clarification of Question by torodbull-ga on 31 Dec 2003 07:52 PST

I am in California, but this question is posed for any state in the United States.

Hello -

If you choose to rate this answer, please ask for any necessary
clarification or information you may require before doing so.  Thank
you for your understanding.

I consulted with a local CPA, the IRS, an administrator at Jacobson
Jarvis Certified Public Accountants, and a rep from Nonprofit
Assistors, LLC to research this answer.  I also talked with my father,
who actually runs a 501c3 humanitarian aid organization as well.

The answer to your quesion is: because this is "borrowed money" and
not income, you do no have to pay any income tax.  Because you'll be
paying this money back, it's actually just a type of expense.  You're
basically just transferring your existing debt to another entity
(presumably at a lower interest rate).

There should be no penalty (tax or otherwise) involved with this
action provided that you are using the money for the reason you cite,
and there's no "private benefit" being seen by anyone from the money. 
Areas of question could arise if there is an affiliation between the
officers of the charity and the life insurance provider.


Select sources contact:

Jacobson Jarvis Ceritified Public accountants
http://www.jjco.com/svc_tax.html
- administrator

Nonprofit Assistors LLC
http://www.nonprofitassistorsllc.com/Contact.htm

Nonprofit IRS Hotline
877-829-5500

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Request for Answer Clarification by torodbull-ga on 01 Jan 2004 09:27 PST

jbf
Thank you for your thorough research.
Please define "personal benefit derived"; thank you, and have a terrific '04.

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Request for Answer Clarification by torodbull-ga on 01 Jan 2004 09:29 PST

jbf
Thank you for your thorough research.
Please define "private benefit"; thank you, and have a terrific '04.

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Clarification of Answer by jbf777-ga on 01 Jan 2004 10:12 PST

torodbull -

Thanks for your question.

According to this page:

Systems office of Budget and Accounting (A&M University)
http://sago.tamu.edu/soba/TaxManual/Prvinur.html

"Private benefit" is defined as:

A transaction or exchange between a tax-exempt organization and one of
its "insiders" that furthers private interest (typically the interests
of the "insider"), rather than the public interest. (IRC Section
501(c)(3); IRS Treasury Regulation 1.501(c)(3)-1(c)(2)). If private
benefit is found to exist in a tax-exempt organization, it can be the
basis for revocation of the tax-exempt status of that organization.
Any private benefit from an activity must be "incidental" in both a
"qualitative" and a "quantitative" sense to the overall public benefit
of the activity.

-

So long as the transaction is for the furthering of the charity itself
and no specific individual, you should be safe.


Please don't hesitate to ask any additional questions.

jbf

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Clarification of Answer by jbf777-ga on 01 Jan 2004 10:12 PST

You have a happy new year as well!

I could not have asked for a more thoroughly researched answer; kudos
and thanks to this scholar.

Anytime!  Many thanks for the kind words, 5-star rating, and generous
tip!  Please let me know if you have any additional questions.

jbf