The Basics of a Michigan Private Foundation (Part 5) -- Excise Tax Issues
Excise taxes are the bane of private foundations everywhere. These tax rules and restrictions are much more onerous for private foundations than what public charities face. As such, unless there is some personal or business reason why someone would want to conduct their charitable activities through a private foundation, from a pure tax adminstration angle, obtaining public charity status is usually preferable to being classified as a private foundation.
There are a number of excise tax provisions that are imposed on private foundations and its managers to make sure the foundation is operated properly:
Minimum Payout. A private foundation is required each year to make qualifying distributions for charitable purposes equal to or exceeding 5% of the fair market value of its net investment assets. Payment must be made prior to the following taxable year in which the contribution is made. If the foundation exceeds the 5% payout, the excess reduces the required distribution over the next 5 years. Newly-created foundations may have 5 years to satisfy minimum payout distribution requirement. Failure to distribute the minimum payout results in a 15% excise tax with an additional excise tax of 100% if the foundation fails to correct the deficiency in a timely manner.
Net investment income. Foundations must pay an excise tax equal to 2% of its net investment income. The excise tax is reduced to 1% if the foundation makes qualifying distributions in excess of its average distribution over the prior 5 years.
Self-dealing. If a disqualified person engages in self-dealing, a 5% excise tax is imposed of the amount involved on each act of self-dealing per year which increases to 200% if not timely corrected. Self-dealing includes the following acts between the foundation and a disqualified person: sale or lease of property, furnishing goods or services, and payment of compensation. A disqualified person includes substantial contributors (more than $5,000 during the year) and family members.
Jeopardy Investments. If the foundation invests its assets in a manner that jeopardizes its exempt purposes, a 5% excise tax is imposed increasing to 25% if not timely corrected. No investment is per se unacceptable but the following types of investments are carefully scrutinized: margin trading, commodity futures, warrants, and selling short.
Taxable Expenditures. A foundation is precluded from making taxable expenditures to influence legislation and distributing grants to individuals (unless prior IRS approval is obtained), and other private foundations (unless procedures are established that the grant will be used for its designated purpose). The excise tax is 10% of the taxable expenditures increasing to 100% if not timely corrected.
Excess Business Holdings. A 5% excise tax is imposed on the foundation's excess business holdings increasing to 200% if the deficiency is not timely corrected. Under these provisions, a private foundation and all disqualified persons cannot own more than 20% of a business not substantially related to its charitable purpose. The percentage can increase to 35% if a third person other than disqualified persons control the business. If the foundation acquires the business by gift, it has 5 years to dispose of the enterprise without tax.
