Over the years we have reviewed thousands of tax returns from private foundations (PFs). We have found that many accountants are unfamiliar with the nuances of the highly specialized form. As a result, you could miss important opportunities for the PF and unknowingly subject the PF to scrutiny.
These often missed opportunities with the 990-PF can result in savings for PFs:
- Administration costs not included. Some authors believe that only grants meet the Minimum Distribution Requirement (MDR) of a PF. Indeed, legitimate administrative costs count to the satisfaction of the MDR, and if left unaddressed, it can lead to a PF getting mixed up and granting rash grants (and possibly wasting funds) to avoid a penalty. A better understanding of qualified spending can maximize the funds available for planned strategic grants.
- Not Use of investment-related expenses to offset investment income. Often times, yield builders do not apply investment-related costs to offset investment income, resulting in a higher tax burden on the PF.
- Failure to determine eligibility for the reduced tax rate of 1%. The investment income excise tax for PFs has historically been at a default rate of 2%, with the option of reducing that rate to 1% if certain distribution requirements are met. Although recent legislation has simplified the excise tax rate to a flat rate of 1.39% for tax years beginning after December 20, 2019, it is important to ensure that the section on determining eligibility for the 1% rate applies to all tax returns for tax years the start is made before this date. In our experience, the creators are often unable to fully complete this part of the return!
- Improper calculation of excess grant transfer. For each year in which a PF grants significantly more than its MDR, the excess grants can be “booked” as a grant transfer to help meet the MDR for a future year. The transfers expire if they are not applied to the PF’s MDR within five years. If creators miscalculate and apply transfers, the harm isn’t limited to a missed opportunity. Miscalculations actually call the PF’s true MDR into doubt and create the false and dangerous impression that the PF has met its MDR when it has not. For the correction, it may be necessary to submit changed returns worth several years.
The 990-PF is a potential minefield for careless or inexperienced tax advisors. Here are just a few of the most common mistakes:
The form cannot be filled out completely and correctly. Preparers often make several common mistakes. First, there are often inaccuracies that assets reflect on the balance sheet. In addition, capital gains or losses from the sale of a donated asset are often miscalculated because the donor’s transfer base is not applied. After all, many returns are submitted with no mandatory attachments or schedules. These errors can lead to confusion with an Internal Revenue Service auditor or misjudgment of the excise duty due, resulting in additional penalties.
Incorrectly calculate MDR. Returners often incorrectly calculate the MDR and achieve a value that is far below the actual amount. If a PF does not meet their MDR in a given year, they must file a Penalty Statement (Form 4720) and are punished with a 30% penalty on the shortfall.
Use of the accrual accounting method to demonstrate satisfaction with MDR. Treasury regulations mandate that even PFs using this common accounting practice for financial reporting purposes must use cash accounting to determine whether a PF has met its MDR. Using the accrual method can result in a penalty of 30%.
Missing estimated tax payments. Larger PFs with even moderate investment returns may be required to make quarterly estimated tax payments. Without the proper guidance of their creators, many PFs are penalized for not making these interim payments on time or at all.
Foundation Insiders cannot be tracked. A PF is expected to keep an eye on all individuals and organizations that are considered insiders (technically “disqualified individuals”). Insiders who make significant contributions to the PF are prohibited from engaging in financial transactions (e.g., sales, loans, and leases) with the PF. If you get involved in them, it may lead to a violation and penalty of proprietary trading. Any insider who trades himself is personally responsible for a 10% penalty that the IRS cannot award, even if accidentally, well-intentioned and beneficial to the PF. The preparers often do not properly report material contributions to annual returns and do not keep track of who is materially contributing to the PF. As a result, the board of directors or officers of a PF may fail to recognize that certain individuals or companies are insiders with respect to the PF and may allow the PF to engage in prohibited transactions.
Jeffrey Haskell, JD, LL.M. is Chief Legal Officer at Foundation Source, which provides comprehensive support services to private foundations. Contact him at [email protected].