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January 18, 2021

Tax-exempt Status of Private Foundations

Private foundations fall under section 501(c)(3) of the IRC which means they are also exempt from federal income tax. Private Foundations typically receives funds from a limited number of sources. A private foundation’s charitable activities often consist of giving grants to other charitable organizations that carry out actual charitable works. Most Private Foundations are required to make a minimum amount of distributions per year to keep their 501(c)(3) status. However, if a foundation directly engages in charitable works, it may not be bound on making minimum grants per year.

Minimum Contributions

Private foundations that do not directly carry out some form of charitable activity are referred to as non-operating private foundations. These foundations are required to make a minimum amount of donations per year to maintain their 501(c)(3) status. Generally, the minimum amount required to be contributed to public charities that are actually involved in charitable work is 5% of the private foundation’s investment assets. Failure to make these minimum contributions could result in the foundation incurring excise taxes.

Contributions to other private foundations are generally not allowed except in special circumstances. For example, the Buffet Foundation has donated about $2.9 billion of the $37 billion pledged, to the Bill & Melinda Gates Foundation because the latter has a better infrastructure in place to make grants to health and educational institutions throughout the world.

Excise Taxes & Private Foundations

Private Foundations like other 501(c)(3) organizations are exempt from income tax but are subject to excise tax of 1 to 2 % on net investment income. Note that Exempt Operating Foundations are generally exempt from paying excise taxes. To be considered an exempt operating foundation, a private foundation must meet the following criteria:

  • Must have been publicly supported for at least 10 years,
  • Must have a governing body consisting of individuals less than 25% of whom are disqualified individuals,
  • Must be broadly representative of the general public,
  • Must have no officer whom is a disqualified individual during the year.

The Internal Revenue Code contains a number of excise taxes that can be imposed on officers and trustees, and foundation managers who knowingly participate in ‘prohibited transactions’. A transaction is considered prohibited if it involves the transfer of value between disqualified persons and a foundation. For example, payment of compensation by a private foundation to a disqualified person beyond the scope of the foundation’s exempt purpose.

Failure to address the prohibited transaction within a specified time period will result in an excise tax increase of up to 200% of the amount involved in the prohibited transaction. The foundation manager involved in the transaction could also incur as much as 50% of the amount in the prohibited transaction.

Section 13602 of the Tax Cuts and Jobs Act, imposes an excise tax equal to the corporate rate of 21% on remuneration (remuneration simply means wages) in excess of $1 million (parachute payments) paid by a Private Foundation to a covered employee.

Private Foundation Tax Returns

Foundations are required by law to file an annual information return with the IRS on Form 990-PF, and also file a copy with its state of incorporation. In order to file an accurate Form 990-PF, a foundation must maintain accurate books and records of its contributions throughout the year. Hiring a professional bookkeeper can help a foundation avoid certain excise taxes and also help determine if your foundation is liable for Unrelated Business Income Taxes. Contact the Urich CPAs, for a free consultation.

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