Written by David Wheeler Newman
Senators Chuck Grassley and Angus King on June 9 announced their intention to introduce tax legislation, dubbed the “Accelerating Charitable Efforts Act”, or the “ACE Act”, that would have major impacts on donor advised funds (DAFs) and private foundations. This post will discuss the proposed changes to the private foundation rules, and the next post will discuss those affecting DAFs.
The ACE Act would change the private foundation rules in three areas, with each change intended to increase distributions from private foundations to the charitable institutions and programs they support.
Tax on Investment Income
The first area is the excise tax at the rate of 1.39% paid by private foundations on net investment income (e.g. dividends, interest, capital gains, rents and royalties). Under the ACE Act, a private foundation would not owe this tax if it distributes at least 7% of the value of its assets (other than assets held or used for charitable purposes), less certain debt attributable to those assets, as opposed to the current general minimum required distribution (MRD) of 5%. The investment tax would also not be owed by private foundations organized for a fixed term of 25 years or less that do not make distributions to other private foundations under common control.
Private Foundation Distributions to DAFs
The second private foundation area that would be affected by this legislative proposal relates to private foundation distributions to DAFs. Many foundations currently use DAFs to address various issues. While some foundations make distributions to DAFs to satisfy their MRD – the obvious target of the ACE Act proponents since those distributions might be “warehoused” in the DAFs rather than put to their ultimate charitable purposes – other foundations make use of DAFs to simplify administration by making one distribution to the DAF and leaving it to the DAF sponsor to write and send small checks to multiple charitable grantees. Family members concerned about privacy may prefer the anonymity of giving through a DAF, since grants made by their private foundation appear on its tax return, which is available to the public.
To avoid excise taxes, a private foundation must make qualifying distributions (QDs) for charitable purposes at least equal to its MRD. Under current law, a private foundation distribution to a DAF is a QD, since the DAF sponsor is a publicly supported charity. Under the ACE Act, a private foundation distribution to a DAF would only be a QD to the extent the DAF makes qualifying DAF distributions by the end of the DAF sponsor’s tax year following the year in which the funds are received from the private foundation.
Private foundations are already required to report distributions to DAFs on their tax return, and this reporting requirement would continue under the proposed Act.
The current private foundation rules allow administrative expenses that are paid to accomplish the charitable purposes of the foundation to be treated as a QD, counted toward satisfying the MRD. The ACE Act would not count these administrative expenses if paid to a disqualified person (generally substantial contributors to the foundation, their family and associated entities) other than trustees, officers or directors of the foundation who are not members of the substantial contributor’s family. The patriarch’s grandson could still be paid to run the family foundation, but his compensation would no longer be counted toward the MRD.
These changes to the private foundation rules, if enacted, would become effective for tax years beginning after December 31, 2021.