Natalya Attestatova, CPA

Excise Taxes on Private Foundations

March 27th, 2010

Excise Tax on Investment Income

Net investment income (dividends, interest, royalties, net operating gains LESS directly related expenses) is taxed at 2%, unless foundations make additional distribution for charitable purposes, then it is taxed at 1%.

Self-Dealing

This provision penalizes almost ANY transaction between the foundation and its ”disqualified person” (which we will discuss later), even if the transaction was at arm’s length and benefits the foundation. The penalty is 5% of the amount involved in self-dealing imposed on the self-dealer and 2-1/2% (with $10,000 maximum) on foundation managers who knowingly participate in the transaction. However, the IRS will allow the organization to correct the problem (i.e. the self-dealer to pay the organization back) and will assess the tax only if the situation is not remedied.

Minimum Distribution Requirements

Private foundations must make annual “qualifying distributions” in the amount of 5% of the fair market value of their net investment assets. If the organization fails to do so, the IRS will assess 15% penalty on the undistributed income and if the funds are not distributed within a specified period, the IRS will assess 100% penalty.

          Qualifying distributions are:

• grants for charitable purposes;
• reasonable administrative costs related to the grantmaking process
• payments to purchase assets used in conduct of the foundation’s activities
• expenses of conducting direct charitable activities
• amounts set aside for future projects
• program-related investments

Excess Business Holdings

The rationale for this penalty tax is the position of Congress that it is inappropriate for a private foundation to hold a substantial share of the principal donor’s family business.

If the percentage is owned by disqualified persons – the holding allowable for the foundation is determined as follows: 20% minus the percentage owned by disqualified person. For example, if a disqualified person owns 4%, the foundation can own 16% of the business.

If the percentage is owned by not disqualified persons – the 20% above is substituted for 35% – i.e. the combined share allowable is 35%.

The foundation is allowed to own less than 2% of any business regardless of the percentage held by disqualified persons – this is known as the de minimus rule.

The amount of tax imposed is 5% of the value of the excess holdings. If the foundation fails to divest the unallowed shares within the specified period (which can be between 5 to 10 years), the penalty becomes 200%.

Jeopardy Investments

If an organization invests its funds in a manner that jeopardizes the carrying out of its exempt purposes, the penalty is 5% on the amount invested. There is also 5% penalty ($5,000 maximum) on foundation managers who knowingly participate in the jeopardy investments. If the organization fails to make necessary correction, there is an additional 25% penalty against the foundation and 5% penalty (with $10,000 maximum) against managers.

Taxable Expenditures
Any expenditures for noncharitable purpose, such as lobbying, electioneering, voter registration, grants to individuals, grant to any organization that is not a public charity. The penalty of 10% of the prohibited expenditure is imposed on foundation and 2-1/2 % on foundation’s managers ($5,000 maximum). If the action is not corrected, additional tax of 100% is imposed on foundation and 50% on the managers ($10,000) maximum.

Entry Filed under: Non-Profit Organizations