Chances are you spend a lot of time focusing on your income tax projections before year-end but probably don’t do any tax planning for your private foundation. However, strategic moves could save your foundation tax dollars that could be used to further its exempt purpose.
Don’t Pay More Tax - 2% vs 1%
Private foundations generally pay a 2% excise tax each fiscal year on its net investment income when filing Form 990-PF private foundation can have its excise tax reduced to 1%, if the foundation meets certain distribution requirements. That is, a private foundation can cut its tax rate in half (from 2% to 1%) if the amount of the qualifying distributions made by the foundation during its fiscal year equals or exceeds the sum of:
Know what the threshold is before year-end in order to possibly qualify for the reduced 1% rate of tax. You can then decide whether or not to make additional qualifying distributions in order to reap the benefit. A small amount of additional qualifying distributions could generate significant tax benefits if it gets you over the hurdle. And, the additional qualifying distributions could be an acceleration of pledges that you need to make in any event.
In arriving at net investment income, the private foundation is allowed certain deductions including advisory fees, commissions, interest, compensation, occupancy.
Go through the Foundation’s expenses carefully and allocate expenses as either investment related or related to charitable purposes. Any expense related to the production of investment income will be netted against investment income and lower the foundation’s excise tax.
Don’t Lose Your Net Capital Loss
A private foundation generally pays tax on its net investment income. On Form 990-PF, the net capital gains and losses from the sale of property held for investment purposes are a component of net investment income. There is an unusual treatment of capital losses on Form 990-PF. Capital losses from the sale of investment property may be subtracted from capital gains incurred in the sale of other investment property during the same tax year, but only to the extent of the gains. That is, if capital losses exceed the capital gains:
As the end of a private foundation’s fiscal year approaches, the foundation should check to see if it has a net capital gain or loss for the year:
Also, please remember that contributed securities take on the cost basis of the donor.
Interaction with Unrelated Business Income Tax
While a private foundation is generally exempt from income tax, it will be subject to income tax on UBTI (unrelated business taxable income). UBTI is income from a regularly carried on trade or business activity that is unrelated to the private foundation’s charitable purpose. Investment income is generally not considered as UBTI. The tax differential is large with the net investment income tax rate at 2% (or 1% if qualified) versus the corporate tax rate ranging from 15% to 35%. Also if a foundation generates $1,000 or more in gross unrelated business income, it will need to file Form 990-T in addition to Form 990-PF.
Be careful to scrutinize your transactions and identify income that will be subject to the excise tax versus unrelated business income tax. It still may be worth it to make an investment that will generate unrelated business income, but at least you will not be surprised when filing. Be mindful that many Sch. K-1 investments could generate UBTI.
Required Minimum Distribution
Private foundations must make annual qualifying charitable distributions equivalent to at least 5% of its average asset fair market value. Excess distributions can be carried forward 5 years to offset future required annual minimum distributions.
One must plan to properly pay out the required minimum distribution. Otherwise, significant excise taxes could be asserted. The tax is 30% on the portion not distributed within a year. If not distributed after 2 years, an additional 100% excise tax applies.
Sound confusing, we can help. Please call us to discuss the above or any other private foundation questions. Please contact you financial adviser before making any changes to your investments.
Paula Vuksic is a tax partner in Citrin Cooperman’s New Jersey office with more than 25 years of experience in the areas of tax research, compliance, and reporting. She can be reached at 973-218-0500 or at firstname.lastname@example.org.
Joseph Barreca is a tax manager in Citrin Cooperman’s New York office. He can be reached at 212-697-1000 or at email@example.com.