Tax on net investment income of private foundations: Reduction in tax

For tax years beginning January 1, 1985 through December 20, 2019, Section 4940(e) provides for a reduction of the tax rate on net investment in­come from two percent to one percent for any private foundation that meets the following distribution requirements:

1. The foundation makes qualifying distri­butions during the tax year at least equal to the sum of (a) the assets of the founda­tion for the tax year multiplied by its aver­age percentage payout for the base period, plus (b) one percent of the foundation’s net investment income for the tax year, and
2. The foundation was not liable for private foundation excise taxes for any year of the base period.

Average percentage payout is the aver­age of the percentage payouts for each of the tax years in the foundation’s base period.  For each tax year, the percentage payout is figured by dividing the qualifying distributions made dur­ing the year by the foundation’s assets for that year.  If, for any tax year in the foundation’s base period, the foundation’s tax rate on net invest­ment income is reduced to one percent by meeting these distribution requirements, the qualifying distribu­tions made by the foundation during that year must be reduced by the amount of the reduction in tax.

The assets of the foundation for any tax year are the excess of the total fair market value of all the foundation’s assets, other than those used or held for use directly in carrying out the foundation’s exempt purpose, over the acquisi­tion indebtedness with respect to those assets.

The base period with respect to any tax year is the five tax years preceding that year.  If an organization has not been a private foundation throughout those five tax years, the base period consists of the tax years during which the foun­dation has been in existence.  However, if a private foundation is a successor to another private foundation, it must take into account the experience of that other foundation.

Effective for tax years beginning after December 20, 2019, Section 4940(a) was amended to provide a single tax rate of 1.39% on net investment income and Section 4940(e) was repealed. For tax years beginning after December 20, 2019, all private foundations subject to the Section 4940 excise tax on net investment income will calculate the tax using the 1.39% rate.

Return to Life cycle of a private foundation