A private foundation generally pays a 1.39% excise tax each year on net investment income when filing its annual Form 990-PF. Since this is not a large tax, most small private foundations don’t spend much time (if any) on tax planning. While the excise tax rate on net investment income is not substantial, below are some tax planning tips your private foundation may want to utilize.
Net Capital Loss – What you need to know
On Form 990-PF, net capital gains and losses from the sale of property held for investment purposes are included in the calculation of net investment income. The Form 990-PF has an unusual approach to handling capital losses. Capital losses from the sale of investment property can be deducted from capital gains incurred during the same tax year, but only to the extent of the gains. That is, if capital losses exceed the capital gains, the excess loss can’t be deducted against other components of net investment income and the excess loss can’t be carried to other tax years.
Tip #1:
As the end of your private foundation’s tax year approaches, check to see if your private foundation has a net capital gain or loss.
- To avoid losing capital losses:
- If your private foundation has a net capital loss, it could sell appreciated stock to offset the loss and not increase your private foundation’s excise tax liability.
- To avoid paying the excise tax on capital gains:
- If your private foundation has a net capital gain, it could sell depreciated stock to offset the gain and reduce your private foundation’s excise tax liability.
Your financial adviser should be consulted before making any investments decisions. Sometimes selling an investment may not make sense, but other times moving up a sale one month could lead to a potential tax savings (which could be used to further your private foundation’s charitable activity).
Allocating Expenses – Net Investment Income vs. Disbursements for Charitable Purposes
To determine net investment income, a private foundation is permitted to deduct certain expenses including compensation, professional fees, interest and operating expenses.
Tip #2:
Go through your private foundation’s expenses and allocate expenses as either related to charitable purposes or investments. Any expense related to the production of investment income should be netted against investment income and lower the foundation’s excise tax. This may seem like something all private foundations do, but you would be surprised how many small private foundations don’t allocate any expenses to offset net investment income. Some expenses may be allocated partially to charitable purposes and partially to investments. Take the time to go through your private foundation’s expenses and allocate accordingly.
Two Taxes – Unrelated Business Income Tax vs. Excise Tax
While a private foundation is generally exempt from income tax (as mentioned above it generally pays a 1.39% excise tax each year on net investment income), it will be subject to a tax on its unrelated business income (UBI). UBI is income from a regularly carried on trade or business activity that is unrelated to the private foundation’s charitable purpose. Investment income is generally not considered UBI. The difference in tax is large with the net investment income tax rate at 1.39% versus the corporate tax rate of 21%. A foundation that generates $1,000 or more in gross UBI will also need to file Form 990-T in addition to Form 990-PF.
Tip #3:
Carefully examine your Foundation’s activity to identify any investment income that may be subject to unrelated business income tax instead of the excise tax. Schedule K-1 investments could generate UBI and the Schedules K-1 received by your private foundation should be examined carefully for any UBI. No private foundation wants to be contacted by the Internal Revenue Service for not reporting and paying UBI tax on Form 990-T.
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Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.
