CPAs can be a valuable resource for monitoring compliance with the many tax laws unique to private foundations. Awareness of the nuances of private foundation laws is especially important now, given the increased scrutiny of all tax-exempt organizations by Congress and the IRS. Advisers can help prevent inadvertent but costly violations of the tax laws peculiar to private foundations.
Key issues for benefactors considering a private foundation include:. They are usually funded by a single contributor, such as a family or corporation, rather than by the general public, as with a public charity. They may either directly conduct exempt activities operating foundations or make grants and distributions consistent with their exempt status non-operating foundations.
Although private foundations often support other tax-exempt charitable organizations, a private foundation is not what tax law calls a "supporting organization. Nonetheless, CPAs should be familiar with the four types of supporting organizations see Exhibit 1 for resources when advising private foundations. Grants made to a Type III non-functionally integrated supporting organization require additional administrative and reporting requirements. In addition, grants to this type of supporting organization are not included in qualifying distributions for purposes of meeting the distribution requirements.
One alternative to establishing a private foundation is to establish a donor-advised fund with a sponsoring organization. Donors make contributions to sponsoring public charities.
These funds are separately accounted for and associated with a named donor. The donor then has a reasonable expectation of being able to advise the sponsoring organization as to the distribution of these funds.
The donor's role must be advisory, and the sponsoring organization must exercise full control and variance powers over the donated funds. The conventional wisdom has been that donor-advised funds may offer lower administrative costs than private foundations; however, this is not necessarily true.
A remaining benefit of a donor-advised fund is that, unlike private foundations, they are not subject to excise taxes on net investment income. Two major advantages of donor-advised funds survived the PPA, however. Second, the deduction for long-term capital gain property other than publicly traded securities contributed to a private foundation is limited to the donor's basis in the property, while gifts of similar property to a donor-advised fund is not subject to the same limitation.
Depending upon the donor's circumstances and assets, these could be major considerations if a substantial portion of a donor's wealth consists of closely held stock.
It is difficult to establish a contribution threshold at which a private foundation is preferable to a donor-advised fund. Family members of those persons also may be disqualified. Since the self-dealing rules take effect on the day the person's cumulative contributions become "substantial," it is important for foundations to continually monitor contributions against the threshold.
Excise taxes are assessed on the "amount involved" in the transaction, which is generally the greater of the fair market value of cash and property either given up or received by the private foundation. Excise taxes may be imposed even if the self-dealing transaction is at "arm's-length.
However, if a disqualified person provides property for a price to a private foundation, the entire transaction is considered self-dealing. Disqualified persons are allowed to receive compensation for personal services provided to private foundations if those personal services are reasonable and necessary.
An excise tax may be assessed, however, on any compensation or expense reimbursement deemed excessive. Moreover, not all services provided by a person are necessarily considered personal services within the meaning of the exception.
Therefore, a foundation should document the job duties and workload of the disqualified person as well as compensation paid to persons with similar duties and workloads at similar foundations. According to Pantzer of BKD LLP, this is particularly important at small family foundations where second- and third-generation family members are being compensated. The tax laws and regulations applicable to private foundations cannot be navigated by a reasonableness standard. The laws were written to be restrictive and completely eradicate certain practices of wealthy donors.
It is often not relevant if a transaction benefits the foundation at the expense of a disqualified person. Almost always, a transaction between a private foundation and a disqualified person will be considered selfdealing. Having a diverse portfolio is expected to help effectively manage risk. Although diversifying is a requirement, there are exceptions to how quickly a private foundation needs to diversify its portfolio.
The exceptions take into account whether an investment is inherited or gifted to the foundation instead of purchased directly and whether the market is strong or not. Being prudent means not investing in enterprises that lack a reasonable business sense. These jeopardizing investments include: trading in securities on margin, trading in commodity futures, investing in working interests in oil and gas wells, buying puts, calls and straddles, buying warrants and selling short.
The facts and circumstances of how they were acquired and the type of investments play a major role in whether or not the investments are considered jeopardizing and how quickly the foundation needs to let go of them. Holding too much of an investment is considered too risky for private foundations.
Taxes Private foundations are taxed at a 2 percent rate on their net investment income, which is reported on Form PF. The net investment income tax can be reduced from 2 to 1 percent if certain distribution requirements are met. Expenses of private foundations are split between charitable and investment purposes. Evaluating your expense allocations annually is important in determining your true net investment income.
Filing Methods Exempt organizations can use either the traditional paper filing method or electronic filing method to submit their nonprofit tax form information return to the IRS. Paper Filing Filing a return with paper forms is the usual way of providing information to the IRS.
Electronic Filing Electronic filing, or e-filing, is the most preferred method by both organizations and tax professionals to submit IRS Form Steps to E-file Start Now. Schedules for Form Schedules are auto-generated and also available for FREE while filing Nonprofit tax Form with ExpressTaxExempt Form has additional information forms called schedules, which need to get filed along with each return.
There were 16 schedules in total, the organization should file the right schedules based on their activities. ExpressTaxExempt supports most of the schedules of Form This can be auto-generated depending on the information provided during the interview process. ExpressTaxExempt simplifies the process and helps to choose the correct schedules. Once you complete filling your details , you can check and then make a payment to transmit the return to the IRS electronically.
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