With the extended 990-PF filing deadline approaching for private foundations on a calendar year accounting period, foundation leaders should ensure that they have paid the 1.39% net investment income excise tax and should properly report any investment income on the foundation’s 2022 tax return. Below is a quick refresher on calculation of the net investment income excise tax and payment obligations.
Generally, the Internal Revenue Code imposes an excise tax on tax-exempt private foundations’ net investment income. Operating foundations may be exempt from this tax if the foundation has been publicly supported for the past 10 taxable years, no more than 25% of the governing body is made up of disqualified persons, and no officer is a disqualified person. Before the enactment of the Further Consolidated Appropriations Act of 2020, there was a complicated formula to determine the applicable tax rate. As discussed below, the process has been streamlined with the application of a flat 1.39% tax rate.
Tax Base. Net investment income is defined as the excess of a private foundation’s gross investment income and capital gain net income over its allowable deductions. Gross investment income is comprised of the gross amount of income from interest, dividends, rents, royalties, payments with respect to securities loans, and income from sources similar to such items. Importantly, however, gross investment income excludes any such income that is considered unrelated business taxable income of the foundation, as this income would be separately subject to unrelated business income tax imposed under section 511 of the Internal Revenue Code.
Capital gain net income is determined using the traditional capital gain rules, with a few notable exceptions. Like with gross investment income, capital gain net income excludes any such income that is unrelated business taxable income of the foundation. Also, no gain or loss is considered with respect to any portion of property used for a period of not less than one year for the foundation’s exempt purpose or function if the property is exchanged immediately thereafter for property of a like kind that will be used for the same purpose or function.
To determine the net investment income value subject to tax, the sum of a foundation’s gross investment income and capital gain net income is reduced by all ordinary and necessary expenses incurred for the production or collection of gross investment income or for the management of property held for the production of income. These expenses can include compensation of officers, other salaries and wages of employees, outside professional fees, interest, rent, and taxes on property used in the foundation’s operations. Be aware that if any of these expenses are incurred for both investment and exempt activities, the foundation must allocate the expenses between the investment activities and the exempt activities. No deduction is allowed for charitable contributions, net operating losses, or any of the special deductions for corporations or for expenses incurred to carry out the foundation’s exempt purpose.
Tax Rate. As a result of The Further Consolidated Appropriations Act of 2020, private foundations are now subject to tax at a flat rate of 1.39% of their net investment income, effective for taxable years beginning after Dec. 20, 2019. This legislative change significantly simplified the net investment income excise tax for private foundations.
Prior to enactment of that legislation, the tax imposed was 2% of the private foundation’s net investment income for tax years beginning Jan. 1, 1985, through Dec. 20, 2019, and could be reduced to 1% if certain conditions were met. Despite being a slightly higher rate, the current flat rate 1.39% certainly helps foundations more easily calculate their net investment income excise tax liability.
Tax Reporting and Payment. Any net investment income excise tax owed by a private foundation is reported in Part V of its annual Form 990-PF filing. These filings must be made by the 15th day of the fifth month following the end of the foundation’s tax year, or the 11th month if an extension was obtained. For a foundation with a calendar year accounting period, the return is due May 15 of each year, unless extended.
If the amount of net investment income excise tax owed by the foundation does not exceed $500, the foundation may pay the amount through a single payment in connection with the filing of its Form 990-PF return by the original due date, not the extended due date.
However, if the amount of tax is $500 or more, the foundation is required to make estimated installment payments. Foundations should use Form 990-W to calculate the amounts of such installment payments, which are due on the 15th day of the fifth, sixth, ninth and 12th months following the end of the foundation’s tax year. As an example, for a foundation with a calendar year accounting period that is required to make estimated payments, these installments would be due on May 15, June 15, Sept. 15, and Dec. 15.
Form 990-W allows foundations to, most commonly, make four equal installment payments based on the current year’s liability, but also permits payments to be calculated using an annualized income installment method or adjusted seasonal installment method.
In any event, all payments must be paid electronically using the Electronic Federal Tax Payment System.
If a foundation is late paying its net investment income excise tax, either by lump sum or installment payments, a penalty is imposed in the amount of 0.5% of the unpaid tax for each month it is unpaid, up to 25% of the tax. If the late payment was due to reasonable cause, however, no such penalty is imposed. Penalties also may be incurred if the foundation underpays the tax as a result of incorrectly determining the amount of its estimated tax installment payments. Notably, however, this penalty cannot be waived for reasonable cause.