There is an excise tax on the net investment income of most domestic private foundations. This tax must be reported on Form 990-PF, Return of Private Foundation, and must be paid annually at the time for filing that return or in quarterly estimated tax payments if the total tax for the year is $500 or more.
Internal Revenue Code section 4940 imposes an excise tax of 2 percent on the net investment income of most domestic tax-exempt private foundations, including private operating foundations. Some exceptions apply. An exempt operating foundation is not subject to the tax. Further, the tax: is reduced to 1 percent in certain cases.
This tax must be reported on Form 990-PF, Return of Private Foundation. Payment of the tax is subject to estimated tax requirements. For more information concerning payment of estimated tax, see the Instructions for Form 990-PF. Nonexempt private foundations are also subject to this tax, but only to the extent that the sum of the 2 percent tax plus tax on unrelated business income, applied as if the foundation were tax-exempt, is greater than income tax liability for the year.
Example. A taxable private foundation had an income tax liability for 2002 of $10,000. If the foundation were tax exempt, it would have a $4,000 liability for tax on net investment income and a $7,000 liability for tax on unrelated business income. The foundation is liable under section 4940 for $1,000, the amount by which the sum of the tax on net investment income and the tax on unrelated business income ($11,000) exceeds the amount of income tax liability ($10,000).
In addition, the Internal Revenue Code contains five provisions that impose two-tier excise taxes on private foundations, foundation managers, or other disqualified persons that engage in certain prohibited acts. These are the taxes on self-dealing between private foundations and their substantial contributors or other disqualified persons; (2) requirements that the foundation annually distribute income for charitable purposes; and (3) penalty excise taxes designed to discourage behavior detracting from a foundation’s ability to further charitable purposes. Thus, the IRS may assess excise taxes on:
- Certain foundation holdings in private businesses;
- Foundation investments that jeopardize the carrying out of exempt purposes;
- Expenditures for certain activities not furthering exempt purposes.
These penalty excise taxes are reported and paid on Form 4720.
Violation of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, its substantial contributors, and certain related persons. The first tier (initial) tax is automatically imposed if the foundation engages in a prohibited act. With the exception of self-dealing acts under section 4941, the initial taxes may be set aside if it is established that (1) a taxable event was due to reasonable cause and not to willful neglect, and (2) the event was corrected within the correction period.
Instructions to Forms 990-PF
Instructions to Form 4720
Return Due Dates for Exempt Organizations Excise Tax Returns (Forms 4720 and 6069)
DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here.