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With continued challenges, private foundations should proactively focus on their year-end tax strategies to prepare for 2023.
Throughout 2022, the industry continued to focus on the COVID-19 pandemic and political climate, bringing challenges and opportunities for foundations and their grantees.
Learn how to focus on key tax laws and opportunities which could affect your private foundation, as the following sections illustrate:
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
The Taxpayer First Act, enacted July 1, 2019, requires tax-exempt organizations to electronically file information returns and related forms. The law affects tax-exempt organizations in tax years beginning after July 1, 2019.
Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation, for tax years ending July 31, 2020, and later must be filed electronically.
Form 990-T, Exempt Organization Business Income Tax Return, for tax years ending December 2020 and later with a due date on or after April 15, 2021, must be filed electronically and not on paper. A limited exception applies for 2020 Form 990-T returns submitted on paper that bear a postmark date on or before March 15, 2021.
Notice 2021-01 provides that as a result of this electronic filing mandate, each taxpayer filing Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code (IRC), must file their own return.
Taxpayers such as disqualified persons and foundation managers can no longer rely on Treasury Regulation Section 53.6011-1(c) to report and pay an excise tax reported on Form 4720 on the private foundation’s return.
For tax years ending December 2020 and later with a due date on or after July 15, 2021, a private foundation filing Form 4720 must file the return electronically.
A limited exception applies for 2020 Form 4720 returns submitted on paper that bear a postmark date on or before June 15, 2021.
Priorities for FY2022 have been to collaborate across the IRS on existing and emerging issues, such as:
There has been an increased focus on exams of high-income taxpayers with tax-exempt entity issues, including foundations’ tax filings being pulled into examinations of estates and high-income individual tax return filings due to large charitable contribution deductions.
The IRS Tax-Exempt/Government Entities (TE/GE) division published their FY2021 accomplishments letter earlier this year. Below are some items to note from their accomplishments letter:
The Inflation Reduction Act allocated approximately $80 billion to the IRS over the next ten years. The IRS indicated their FY2023 program and priorities as listed below.
This IRS noted promoting the use of taxpayer digital communications to taxpayers and representatives, increasing access to tax services throughout Indian Country, and more.
The Accelerating Charitable Efforts Act (ACE Act) bipartisan legislation was introduced on June 9, 2021. The legislation was introduced in the Senate in February 2022. The bill’s provisions spurred some debate in the sector, but the proposals haven’t been enacted as of the date of this article.
The initiative’s proposed reforms seek to change certain rules around the private foundation 5% minimum distribution requirement so that salaries or travel expenses paid to foundation managers won’t count as charitable distributions.
The proposal includes a provision so that most distributions by private foundations to donor-advised funds wouldn’t count against the 5% minimum distribution requirement — ending the ability of private foundations to meet the 5% distribution requirement by making a distribution to a donor-advised fund.
The proposed reforms would also eliminate the 1.39% annual net investment income excise tax for any year in which a private foundation pays out 7% or more of the fair market value of its assets or agrees to limit its life span to 25 years or less.
Disruption from COVID-19 continues to strain individuals and organizations, including private foundations; however, as outlined below, legislation could provide private foundations or their grantees relief and assistance concerning tax credits and more. Some of the below opportunities may require filing amended returns and have dates for which to file by due to the statute of limitations.
Under the Employee retention credit (ERC), in 2020, employers could obtain a credit of 50% for qualified compensation paid to employees, up to $10,000 for all quarters. The credit is refundable and applicable against other payroll taxes.
The Consolidated Appropriations Act of 2021 and the American Rescue Plan Act (ARPA) of 2021 extended the ERC credit through June 30, 2021, and further to Dec. 31, 2021. However, it was then terminated early on Sept. 30, 2021. This article provides details on the eligibility requirements during qualified quarters and how employers could qualify.
This credit is for eligible employers that must pay compensation to employees who can’t work because they’re in self-quarantine, caring for someone in quarantine, or caring for a child because of school or other care facility closures.
The credit is limited to a daily amount dependent on the reason for the leave. Learn more in our webcast.
In addition to the paid sick leave credit, eligible employers can receive a credit for compensation paid to employees who can’t work due to caring for a child because of school or other care facility closures.
Limitations also apply to compensation eligible for the credit. Get additional details in our article.
On March 13, 2020, former President Donald Trump declared a national emergency in response to COVID-19. Under IRC Section 139, private foundations may provide assistance to employees and their families following the declaration of national emergency without the risk of incurring certain tax liability.
Due to the COVID-19 pandemic, many private foundations are exploring ways to provide disaster-relief assistance to those in need — including individuals, for-profit businesses, governments, and foreign organizations. These payments could likely be eligible for treatment as a qualifying distribution.
However, due to restrictions around private foundations, consider several factors regarding these funds, including:
Private foundations that wish to launch a disaster-relief assistance program should consult with their tax advisor.
Private foundations can continue to plan for a flat tax rate on net investment income for now.
Effective for tax years beginning after Dec. 20, 2019, the following changes apply:
For tax years beginning after Dec. 20, 2019, all private foundations subject to IRC Section 4940 excise tax on net investment income calculate the tax using the 1.39% rate.
Learn more about the flat tax rate and other important tax changes for foundations in our article.
IRC Section 4942 imposes a minimum distribution requirement on nonoperating private foundations. Foundations that fail to meet this requirement must pay an excise tax.
The following expenses are qualifying distributions if they’re incurred while implementing a foundation’s charitable purpose:
Qualifying distributions are determined on the cash receipts and disbursements method of accounting, regardless of the accounting method used to maintain a foundation’s books and records.
These distributions must be made by the end of a foundation’s succeeding tax year. For example, if the undistributed requirement for 2021 was $500,000, qualifying distributions of $500,000 must be made by the end of the 2022 tax year.
Foundations should determine whether they met the minimum distribution requirement for prior years by the end of the 2022 tax year. If not, they should make final qualifying distributions before the last day of the tax year to avoid the excise tax.
Foundations may also want to consider incorporating the current- and future-year minimum distribution requirements into their planning strategies.
A foundation’s strategic plan can be invaluable, particularly when determining how to increase the use of any carryforwards.
A private foundation that distributed more than its minimum required distribution in a previous year could have an excess-distribution carryforward, which it must use within five years.
To determine gross investment income, a foundation must add net capital gains to the net investment income used to calculate excise tax.
Capital losses from the sale, or other disposition, of investment property can reduce capital gains recognized during a tax year. However, these losses can’t go below zero for a private foundation, regardless of whether it’s set up as a corporation or trust.
This means if capital losses exceed capital gains in a tax year, the excess might not offset gross-investment income in that year. The excess can’t be carried back or forward to offset gains in prior or future tax years either.
A foundation can review its portfolio to determine if it’s beneficial to trigger capital gains before the end of the year. This can help a foundation offset excess capital losses and avoid losing their benefit.
Depending on the circumstances, a foundation could repurchase the sold assets or buy replacement investment assets. This would result in a stepped-up tax basis that would reduce the future gain when the investment asset is eventually sold. Alternatively, a foundation may want to trigger losses to offset capital gains.
With some exceptions, the rules limit how much donors may identify for charitable deductions of certain privately held stock and highly appreciated property.
Donating property encumbered with debt may require a donor to pay a self-dealing tax, and a foundation is forbidden from entering into a sale or exchange with a disqualified person — even if the sale price is less than the fair-market value.
A private foundation may face a liquidity dilemma if it holds a large amount of privately held stock or other non-income producing assets. If the organization holds these assets for investment, they’re included in the minimum required distribution calculation and may not produce sufficient income to satisfy the foundation’s annual payout requirements.
This issue should be considered prior to accepting gifts, and illiquid holdings should be reviewed annually for liquidity concerns.
A private foundation could consider granting an appreciated asset, such as a publicly traded security, to a public charity instead of selling the asset and granting cash.
By doing this, the foundation avoids the excise tax on the security’s inherent capital gain, while still making a grant equal to the asset’s fair-market value. This can be especially valuable because the donor’s basis in the appreciated asset is carried over to the foundation and could result in a substantially large gain.
A foundation should periodically review its gift acceptance policy to verify it covers illiquid gifts and unusual donations.
This preparation can help address donors who propose these types of gifts, especially at year-end.
The IRS stated that virtual currency is property for tax purposes. However, since there is no valid charitable deduction without a contemporaneous written acknowledgement, the major issue is likely to be valuation.
IRC Section 170(f)(11)(E)(ii)(I) criteria for a valid deduction requires that the individual have verifiable education and experience in valuing the type of property for which the appraisal is performed.
A foundation with alternative investments generally receives a Schedule K-1 each year. This form provides necessary information for tax compliance and planning needs.
Alternative investments can do any of the following:
A foundation should seek assistance when determining its potential income-tax liabilities, filing requirements, and estimated income-tax payments that it needs to make before year-end.
Consider leveraging net operating losses (NOLs) to reduce your tax burden.
The 2017 tax reform law affected NOLs in several ways:
Learn more about tax reform’s impacts on NOLs.
The U.S. Department of the Treasury and the IRS issued final regulations for global intangible low-taxed income (GILTI), which taxes U.S. shareholders and controlled foreign corporations (CFCs) on their share of intangible income if that income was subject to a low local tax rate.
For reporting purposes, GILTI is considered a deemed dividend and therefore generally excluded from UBTI. However, even if the inclusion isn’t UBTI and doesn’t create an income tax liability, additional international filings may be required — such as Form 5471 — for taxable years after Dec. 31, 2017.
For private foundations, the deemed dividend created by the GILTI inclusion is subject to net-investment income tax.
The Bipartisan Budget Act of 2018 became law on Feb. 9, 2018. The act includes an exception, known as the Newman’s Own exception, to the excess business holdings rule that the tax on excess business holdings of a private foundation doesn’t apply to independently operated, philanthropic business holdings after Dec. 31, 2017.
Generally, this exclusion must meet three criteria to qualify:
Different operating statuses affect donor deductibility and how a private foundation meets annual payout or spending requirements.
Similar to public charities, private operating foundations provide better tax treatment for donors than private foundations and aren’t subject to the minimum required distribution.
If a foundation directly conducts charitable activities, it should evaluate whether it qualifies as a private operating foundation.
Operating status require two annual tests, an income test as well as one of the following alternative tests:
A foundation must meet both tests in three of the four most recent tax years or in the aggregate over those four years. Private foundations seeking to qualify as a private operating foundation should project if they’ll pass the tests and determine if they need to take any steps before or after year-end.
Learn how to qualify for and retain your status as a private operating foundation in here.
Public charities provide a more favorable charitable contribution deduction threshold. Unlike private foundations, they aren’t prohibited from engaging in certain activities with disqualified persons.
A foundation should consider converting to a public charity if it finds itself:
A private foundation qualifies as a conduit foundation for the purpose of donor-deduction limits if it makes qualifying distributions no later than two and a half months of tax year-end equal to 100% of the contributions received in that same year.
Once a private foundation qualifies as a conduit foundation, its donors can adhere to the adjusted gross income limitation of 60% imposed on cash contributions to public charities — effective for tax years beginning in 2022 — rather than the 30% limit for private foundation contributions.
This includes employing the issue scoring model to develop issues submitted in the Issue Portal for potential compliance strategies. It also covers collaboration across the IRS on existing and emerging issues, including examinations of wealthy individuals and expansion of use of data, machine learning, and artificial intelligence algorithms to select returns for exam.
Workforce development includes revising the Frontline Leadership Readiness Program (FLRP) training to include hands-on training early in the curriculum to set candidates up for success.
This encompasses the deployment of electronic filing of additional returns filed by TE/GE taxpayers, including Forms 5227, 5330, and 8038-CP, as well as the launch of the new consolidated TE/GE Examination Internal Revenue Manual (IRM).
A foundation can make financial assistance payments as long as certain safeguards are in place. Learn about relief payments and next steps for employers in our article.
Tax reform in 2017 created a simplified corporate tax-rate structure, lowering it to a flat 21% tax rate for all corporations and lowering the tax-rate brackets for trusts. Foundations that generate UBTI may stand to benefit from this change.
The requirements for treatment as a conduit foundation must be met on an annual basis, and the foundation must have no undistributed income remaining for the tax year in which the status applies.
