As 2020 comes to a close, private foundations should proactively focus on their year-end tax strategies to prepare for 2021.
Tax reform continues to be a focus for private foundations, with further guidance issued during 2020. The COVID-19 pandemic also brought challenges foundations should address. Below are some of the key tax laws and opportunities that could affect your private foundation.
Focus areas include the following:
More details for each area are provided in the individual sections below.
COVID-19 Relief and Assistance
Disruption from COVID-19 caused strains on individuals and organizations, including private foundations. However, the below pieces of enacted legislation could provide private foundations or their grantees relief and assistance related to loan options, tax credits and deferrals, and more.
For more information on these new provisions, see our comprehensive COVID-19 Implications web page.
Coronavirus Aid, Relief, and Economic Security Act
The Coronavirus Aid, Relief, and Economic Security Act (CARES) Act, enacted on March 27, 2020, provides funding assistance, tax deferrals, and credits to help organizations retain employees.
Paycheck Protection Program
The CARES Act provides funding to the Small Business Administration (SBA), which in turn provides forgivable loans to small business as part of the Paycheck Protection Program (PPP).
To qualify for PPP loan forgiveness, an entity must attempt to retain its workforce and compensation levels when compared to 2019.
The Paycheck Protection Flexibility Act of 2020, enacted June 5, 2020, expanded the provisions of the program. The PPP closed on August 8, 2020, and organizations are now focused on completing the forgiveness applications provided by the SBA.
If your private foundation received a PPP loan, it may qualify for loan forgiveness. Learn about PPP accounting and reporting for private foundations in our article.
Main Street Lending Program
The CARES Act also allowed the Federal Reserve to create a loan program with favorable terms and rates to medium-sized businesses. Two of these loan programs are specifically available to not-for-profit organizations.
To qualify, organizations must:
- Meet the eligible borrowing requirements
- Agree to attempt to retain prior workforce levels
- Limit compensation on certain highly compensated employees
Learn more about available Main Street Lending Program opportunities in our article.
Deferral of Employer Payroll Taxes
Employers may now defer payment of their portion of employee-compensation Social Security taxes. The deferral is through December 31, 2020, with 50% due by December 31, 2021, and the remaining 50% due by December 31, 2022.
Guidance was issued by the IRS, allowing organizations that received a PPP loan to participate in the deferral.
To learn more about payroll tax deferrals and other credits available under the CARES Act, read our article.
Employee Retention Credit for Employers
Under the Employee Retention Credit (ERTC), employers may obtain a credit of 50% for qualified compensation paid to employees, up to $10,000. The credit is refundable and may be applied against other payroll taxes.
To participate, an organization must have experienced either of the following due to government-ordered limitations:
- A substantial reduction in gross receipts
- A full or partial suspension of operations
For organizations with 100 employees or fewer, the credit may include qualified compensation paid to all employees.
Organizations with more than 100 employees may take a credit for qualified compensation paid to employees who didn’t provide services in exchange.
Organizations that received a loan under the PPP aren’t eligible for the ERTC.
Families First Coronavirus Response Act
The Families First Coronavirus Response Act (FFCRA), enacted on March 18, 2020, mandates that certain employers provide paid sick and family leave effective April 1, 2020, to December 31, 2020.
Along with the mandate, the FFCRA includes a payroll tax credit to help impacted employers.
Paid Sick Leave Credit
This credit is available to eligible employers that pay required compensation to employees who can’t work because they’re in self-quarantine, caring for someone in quarantine, or caring for a child because school or other care is closed.
The credit is limited to a certain amount per day depending on the reason for the leave. Learn more in our webcast.
Paid Family and Medical Leave Credit
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 school or other care is closed.
Limitations on compensation eligible for the credit also apply. Get additional details in our article.
Disaster Relief Payments to Employees
On March 13, 2020, President Trump declared a national emergency in response to COVID-19. Under Internal Revenue Code (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.
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.
Flat Tax Rate
Private foundations can now plan for a flat tax rate on net investment income. Effective for tax years beginning after December 20, 2019, the following changes apply:
- IRC Section 4940(a) has been amended to provide a single tax rate of 1.39% on net investment income
- IRC Section 4940(e) was repealed
For tax years beginning after December 20, 2019, all private foundations subject to IRC Section 4940 excise tax on net investment income will 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.
Minimum Distribution Requirement
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:
- Directly incurred expenses
- Reasonable and necessary administrative expenses
- Contributions, gifts, and grants paid to individuals and other organizations
- Acquisition costs of assets used in a foundation’s charitable activities in the year the assets are acquired or converted to a tax-exempt use
- Increases in program-related investments
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 2019 was $500,000, qualifying distributions of $500,000 must be made by the end of the 2020 tax year.
Foundations should determine whether or not they’ve met the minimum distribution requirement for prior years by the end of the 2020 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.
Disaster Relief Assistance
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, several factors should be considered regarding these funds, including:
- Assistance must be provided and used for a charitable purpose.
- Assistance must be given to a charitable class. A charitable class must be large or indefinite, and there must be a public benefit to assisting the charitable class.
- If the disaster relief assistance doesn’t fall within the private foundation’s exempt purpose, the organization will need to notify the IRS of the change.
- Assistance may require expenditure responsibility reporting or an equivalency determination so it isn’t considered a taxable expenditure.
- Assistance may require pre-approval from the IRS.
- It’s important to document assistance programs, qualifications, and assessments of recipients.
Private foundations looking to start a disaster-relief assistance program should consult with their tax advisor.
A private foundation that distributed more than its minimum required distribution in a previous year could have an excess-distribution carryforward. This carryforward must be used within five years.
Your foundation’s strategic plan can be invaluable when determining how to increase the use of any carryforwards.
Capital Gains and Losses
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 or not 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 the benefit of these losses.
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.
Privately Held Stock and Highly Appreciated Property
With some exceptions, donors are limited in the charitable deductions allowed for 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 full-market value.
A private foundation may face a liquidity dilemma if it holds a large amount of privately held stock or other nonincome producing assets.
If these assets are held 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.
Appreciated Asset Grants
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.
Gift Acceptance Policy
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.
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:
- Generate unrelated business income that needs to be reported on a Form 990-T
- Generate state-tax liabilities or filing requirements
- Trigger one or more foreign disclosure filings, such as Forms 926, 8938, 8865, or 8621
A foundation should seek assistance when determining its potential income-tax liabilities, filing requirements, and estimated income-tax payments that should be made before year-end.
Unrelated Business Taxable Income
Under prior tax law, a foundation paid tax on the net of all taxable unrelated business income (UBI) activities at either the corporate or trust income tax rates, depending on the structure of the foundation.
However, final tax reform legislation introduced in 2017 requires each unrelated trade or business activity be reported separately, rather than netted with tax paid on the profitable activities. This means a foundation needs to track UBI activities separately and track net operating losses (NOLs) by activity rather than in total.
The IRS published proposed regulations in April 2020 related to the rules for unrelated business taxable income (UBTI) and final regulations in November 2020. The regulations build on the prior guidance released in IRS Notice 2018-67 but also simplify and clarify some areas.
The final regulations allow private foundations to categorize UBI activities based on just the first two digits of the NAICS code, which designate the sector of a trade or business.
Qualified Partnership Interests
The IRS’s final regulations permit, but don’t require, a foundation to aggregate its UBTI from all qualified partnership interests (QPIs)—including those conducted by lower-tier partnerships—if the de minimis or significant participation tests are met or the partnership interest was held as of August 21, 2018.
- De minimis test. This test is met if a foundation directly holds no more than 2% of the profits and no more than 2% capital interest in a partnership. The proposed regulations simplified this test. Previously, under Notice 2018-67, investments held by disqualified persons, controlled entities, or related supporting organization were required to be included in the total amount held.
- The significant participation test. This is met if a foundation, controlled entities, or related supporting organizations directly hold no more than 20% of the capital interest and don’t have control or influence over the partnership. The proposed regulations simplified this test as well, excluding investments held by disqualified persons in the determination of the amount held.
Income from debt-financed property is also considered an investment activity and can be aggregated with qualifying partnership and S corporation investments.
S Corporation interests that don’t meet the de minimis or significant participation tests are treated as separate activities. This income can’t be grouped with income from other activities, even if the activities are the same.
Corporate Tax Structure
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 Taxpayer Certainty and Disaster Tax Relief Act of 2019 retroactively repealed IRC Section 512(a)(7), which effectively imposed unrelated business income tax on qualified transportation fringe benefits offered by exempt organizations.
Section 302 of the legislation repealed IRC Section 512(a)(7), which was added to the code by the 2017 tax reform. This change is effective “as if included in the amendments made by Section 13703 of Public Law 115-97,” meaning IRS Section 512(a)(7) is repealed as if it were never enacted.
A taxpayer must amend their prior year return to obtain a refund. Learn details and next steps in our article.
Net Operating Losses
Tax reform affected net operating losses (NOLs) in several ways:
- The carryforward period is indefinite rather than limited to 20 years.
- The opportunity to carryback losses has been removed for those losses generated in years starting after December 31, 2017.
- New losses generated are limited to offsetting taxable income in a given year to 80% of taxable income rather than 100%. These losses can only be used to offset taxable income from the trade or business that generated the NOL.
- Losses generated before January 1, 2018, can be used to offset 100% of taxable income from any source, including qualified transportation and parking benefits, until exhausted.
Learn more about tax reform’s impacts on NOLs in our article.
The CARES Act
The CARES Act restored several aspects of NOL carrybacks and carryforwards. Losses arising in any taxable year beginning after 2017 and before 2021 can be carried back up to five years.
Losses arising during those taxable years can also be carried forward to offset 100% of income rather than 80%. Taxpayers can elect to forgo the carryback and instead carry losses forward to future tax years.
Learn how these NOL rules could help your private foundation increase cash flow in our article.
The US Department of the Treasury and the IRS issued final regulations for global intangible low-taxed income (GILTI), which taxes US 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 December 31, 2017. For private foundations, the deemed dividend created by the GILTI inclusion is subject to net-investment income tax.
Bipartisan Budget Act
The Bipartisan Budget Act of 2018, also known as the Newman’s Own exception, was signed into law on February 9, 2018. Included in the act is an exception to the excess-business-holdings rule that states the tax on excess business holdings of a private foundation doesn’t apply to independently operated, philanthropic business holdings after December 31, 2017.
Generally, three tests must be met to qualify for this exclusion:
- Ownership of 100% of the voting stock is held by the foundation at all times throughout the year and was acquired by means other than purchasing.
- All profits go to charity.
- The foundation is an independent operation in terms of board, employee, or trustee positions.
Learn more about this exception and potential benefits in our webcast.
Private Operating Foundation Status
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 or not it qualifies as a private operating foundation. Two annual tests are required for operating status, an income test as well as one of the following alternative tests:
Both tests must be met 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 any steps are required before or after year-end.
Learn how to qualify for and retain your status as a private operating foundation in our article.
Conversion to a Public Charity
Public charities provide a more favorable charitable contribution deduction threshold. They aren’t prohibited from engaging in certain activities with disqualified persons, from which private foundations are disallowed.
A foundation should consider converting to a public charity if it finds itself:
- Consistently receiving contributions from multiple donors—not just the individual or corporation that founded the foundation
- Holding fundraising events
- Meeting the support test as an operating foundation
Conduit Foundation Status
A private foundation qualifies as a conduit foundation for the purpose of donor-deduction limits if the foundation 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 through tax years beginning in 2022—rather than the 30% limit for private foundation contributions.
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.
CARES Act Changes
Under the CARES Act, individuals are now able to take a charitable tax deduction up to 100% of their adjusted gross income (AGI) for qualifying donations made in 2020. Corporations are able to take a 25% deduction on qualifying donations made in 2020.
To qualify, the donation must be made in cash to certain public charities under Section 170(b)(1)(A). Conduit as well as operating foundation status allow a private foundation to qualify as a public charity for this purpose under Section 170(b)(1)(A)(viii).
Learn more about key CARES Act changes and implications for individuals in our article.
We’re Here to Help
As regulations change and markets continue to fluctuate, it’s important for your private foundation to plan for the future.
Our professionals provide a range of services to help private foundations address tax compliance, mitigate consulting issues, and benefit from regulation developments. For example, important resources like a planning analysis can help your private foundation forecast up to 20 years into the future to plan for your minimum distribution requirements.
Planning Analysis Benefits
A planning analysis can help your foundation:
- Gain insight into necessary actions your foundation can take—based its specific goals—to meet payout requirements and comply with applicable regulations.
- Run minimum distribution requirement estimates based on a variety of selection criteria, such as investment-return rates or large contributions to the foundation.
- Estimate and utilize excess distribution carryover, especially amid volatile markets.
This analysis can provide a full view of your foundation’s minimum distribution requirements environment, helping you better manage your distributions as your investment and donor mix evolves. It can also help you navigate the challenges of investing your foundation’s assets.
To learn more about how this information may apply to your foundation or for help creating a strategy, contact your Moss Adams professional.