Tax Act Simplifies the Private Foundation Excise Tax on Investment Income

Taxpayer's desk and excise documents to import and export industrial goods for the purpose of maximizing profits for large business organizations.
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Written by David Wheeler Newman

Tax legislation that was included in the massive spending bill signed by the President included provisions affecting the charitable sector.  We previously reported on one provision involving the reviled nonprofit parking tax and on another provision granting temporary tax benefits for donations targeting disaster relief.  Another provision will be good news for private foundations and their advisors.

Section 4940 of the Internal Revenue Code imposes an excise tax on the net investment income of private foundations.  (Foundations are subject to tax on unrelated business taxable income in the same manner as public charities.)  Prior to the Taxpayer Certainty and Disaster Tax Relief Act of 2019, section 4940 involved a two-tiered regime.  Private foundations were generally subject to a 2% tax on net investment income, but the 2% rate could be reduced to 1% for any year in which the foundation’s distributions to charities exceeded its average payout rate over the preceding five years by an amount at least equal to the tax savings resulting from the 1% rate. The complex formula exasperated many foundation administrators and return preparers and required careful monitoring of foundation investments and the pace of grantmaking.

The Act simplifies this excise tax regime by replacing the two-tiered system with a flat rate of 1.39%.  (The odd number results from legislators’ goal of making this change revenue neutral.)  The private foundation world has long advocated for this simplification.

For these purposes, net investment income is the excess of gross investment income (interest, dividends, rents and royalties) plus capital gain net income over allowable deductions.  These allowable deductions are expenses incurred in the production or collection of gross investment income or management of property held for production of such income.

The new flat rate is effective for foundation tax years beginning after the date of enactment, meaning 2020 for calendar year foundations.

Please contact the MSK tax team for more information.

David Wheeler Newman
Allan B. Cutrow
Jeffrey D. Davine

Jeffrey K. Eisen
Robin C. Gilden
Robert J. Lowe

Daniel Cousineau

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