Private foundations need to plan for the future to navigate changing regulations and fluctuating markets. Throughout 2023, the industry shifted its focus from the COVID-19 pandemic to economic and political climates, bringing challenges and opportunities for foundations and their grantees. While inflation increased, the labor market remained strong, but the stock market had it lowest annual returns in nearly 15 years.
Overview of Topics
Private foundations should implement year-end tax strategies to prepare for 2024. Learn more about the following 2023 trends in the corresponding sections:
The Taxpayer First Act enacted on July 1, 2019, requires tax-exempt organizations to electronically file information returns and related forms. The law affects tax-exempt organizations in tax years beginning after July 1, 2019.
For private foundations, specifically Form 990-PF, Form 990-T, and Form 4720 must be filed electronically.
IRS Priorities and Accomplishments
Priorities for fiscal year (FY) 2024 align with the objectives of the IRS Strategic Operating Plan to address underreporting through expanded examinations and other actions. With respect to exempt organizations, these priorities include:
- Better taxpayer experience
- Faster issue resolution
- Smarter enforcement
- Advanced technology and analytics
- Empowered employees
Increased focus on exams of high-income taxpayers with tax-exempt entity issues includes foundation tax filings pulled into examinations of estates and high-income individual tax return filings due to large charitable contribution deductions.
The IRS Tax-Exempt & Government Entities Division (TE/GE) published its FY 2022 accomplishments letter in spring of 2023. Some of its notable items include:
- 3,425 exempt organizations examinations completed
- 78% of these resulted in a tax change
- 35% from a related examination
- 53 revocations were proposed
Exam issues identified:
- Unrelated business income
- Excise taxes
- Employment tax issues, including employee misclassification and taxable fringe benefits
The Inflation Reduction Act allocated roughly $80 billion to the IRS over the next 10 years, beginning 2023. The IRS indicated its FY 2023 program and priorities should do the following:
Enhance Taxpayer Services
This IRS noted promoting the use of taxpayer digital communications to taxpayers and representatives, increasing access to tax services throughout Indian Country and elsewhere.
Strengthen Compliance Activities
This includes employing the issue scoring model to develop issues submitted in the issue portal for potential compliance strategies. It also covers collaboration across the IRS on existing and emerging issues, including examinations of wealthy individuals and expansion of use of data, machine learning, and artificial intelligence algorithms to select returns for exam.
Develop the Workforce
Workforce development includes revising the Frontline Leadership Readiness Program (FLRP) training to include hands-on training early in the curriculum to set candidates up for success.
This encompasses the deployment of electronic filing of additional returns filed by TE/GE taxpayers, including Forms 5227, 5330, and 8038-CP, as well as the launch of the new consolidated TE/GE Examination Internal Revenue Manual (IRM).
Initiative to Accelerate Charitable Giving
Proposed legislation, the Accelerating Charitable Efforts Act, includes a provision that most distributions by private foundations to donor-advised funds wouldn’t count against the 5% minimum distribution requirement—ending the ability of private foundations to meet the 5% distribution requirement by making a distribution to a donor-advised fund.
These two provisions continued to get attention in 2023 as part of President Biden’s Greenbook Proposal of FY 2024.
The proposed reforms would also eliminate the 1.39% annual net investment income excise tax for any year in which a private foundation pays out 7% or more of the fair market value of its assets or agrees to limit its life span to 25 years or less.
Disaster Relief Assistance
Many private foundations have explored ways to provide disaster-relief assistance to those in need as result of the COVID-19 pandemic—including individuals, for-profit businesses, governments, and foreign organizations. These payments could be eligible for treatment as a qualifying distribution.
Considerations regarding funding restrictions and private foundations include:
- 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, with 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.
- Assistance may require expenditure responsibility reporting or an equivalency determination, so it isn’t considered a taxable expenditure.
- Assistance may require preapproval from the IRS.
- It’s important to document assistance programs, qualifications, and assessments of recipients.
Private foundations that wish to launch a disaster-relief assistance program should consult with their tax advisor.
COVID-19 Pandemic Relief and Assistance
Disruption from COVID-19 continues to strain individuals and organizations, including private foundations. However, legislation could provide private foundations or their grantees relief and assistance concerning tax credits. Some of the below opportunities may require filing amended returns and have deadlines affected by a statute of limitations.
Employee Retention Tax Credit (ERTC) for Employers
Under the ERTC in 2020, employers could obtain a credit of 50% for qualified compensation paid to employees, up to $10,000 for all quarters. The ERTC is refundable and applicable against other payroll taxes.
The Consolidated Appropriations Act of 2021 and the American Rescue Plan Act (ARPA) of 2021 extended the ERTC through June 30, 2021, and further to December 31, 2021. However, it was then terminated on September 30, 2021.
the IRS announced on September 14, 2023, that it would immediately stop processing ERTC claims to protect organizations from scams, but will continue to process those received before that date with a high level of scrutiny.
Disaster Relief Payments to Employees
Former President Donald Trump declared a national emergency on March 13, 2020, 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 provided certain safeguards are in place.
Inflation Reduction Act
The Inflation Reduction Act made significant changes to energy tax credits. For tax years beginning after December 31, 2022, and before January 1, 2033, tax-exempt entities may elect to treat certain tax credits as refundable payments of tax. The Inflation Reduction Act includes almost $400 billion in federal tax credits and other incentives meant to reduce carbon emissions and accelerate the transition from fossil fuels.
Exempt organizations may request tax refunds (new direct pay election) for any amount paid in excess of their tax liability for the following tax credits:
- Section 30C: Alternative fuel vehicle refueling property
- Section 45: Electricity produced from certain renewable resources for projects originally placed in service after December 31, 2022
- Section 45Q: Credit for carbon oxide sequestration credit for projects originally placed in service after December 31, 2022
- Section 45U: Zero-emission nuclear power production credit
- Section 45V: Credit for production of clean hydrogen for projects originally placed in service after December 31, 2022
- Section 45X: Advanced manufacturing production credit
- Section 45Y: Clean electricity production credit
- Section 45Z: Clean fuel production credit
- Section 48: Energy credit (special phaseout rule for direct pay if domestic content requirement isn’t satisfied
- Section 48C: Qualifying advanced energy project credit
- Section 48E: Clean electricity investment credit (technology neutral)
- Section 45W: Credit for qualified clean commercial vehicles
Transferability election allows other taxpayers to monetize credits more easily.
Secure ACT 2.0 Changes to 403(b) Plans
The Secure ACT 2.0 includes several provisions impacting retirement plans, with changes designed to standardize 403(b) plans with 401(k) plans. For example, for plan years beginning after December 31, 2023, Secure 2.0 modifies hardship withdrawal rules for 403(b) plans by aligning them with 401(k) rules.
This act also attempts to increase participation through expanding age limits, contribution limits, and allowing employers to offer de minimis incentives such as low-dollar gift cards. Secure 2.0 increases the required minimum distribution age from 72 to 73 starting on January 1, 2023, and 75 starting on January 1, 2033. Secure 2.0 expands the age for catchup contributions allowing individuals 50 and over to make additional contributions. Individuals with compensation in excess of $145,000 will be required to be made as a Roth contribution.
Conservation Easement Integrity Act
Effective for contributions made after December 29, 2022, this act codifies the 2016 tax shelter listing notice by disallowing a charitable deduction for a qualified conservation contribution if the deduction claimed exceeds two and a half times the sum of each partner’s relevant basis in the contributing partnership, unless the contribution meets a three-year holding period test. Substantially, all of the contributing partnership is owned by members of a family, or the contribution relates to the preservation of a certified historic structure.
In the case of a contribution for the preservation of a certified historic structure, a new reporting requirement applies. Taxpayers are now permitted to correct certain defects in easement deeds, except for easements involved in abusive transactions.
Legacy IRA Act
This act allows a once-in-a-lifetime $50,000 tax-free distribution from individual retirement accounts to split interest entities like charitable gift annuities and charitable remainder trusts, effective for tax years beginning after December 29, 2022. It’s useful for donors receiving required minimum distributions before they need the income for living expenses because it defers taxable income.
Flat Tax Rate
Private foundations can continue to plan for a flat tax rate on net investment income for now.
Effective for tax years beginning after December 20, 2019, the following changes apply:
- IRC Section 4940(a) amended to provide a single tax rate of 1.39% on net investment income
- IRC Section 4940(e) repealed
For tax years beginning after December 20, 2019, all private foundations subject to IRC Section 4940 excise tax on net investment income calculate the tax using the 1.39% rate.
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 2022 was $500,000, qualifying distributions of $500,000 must be made by the end of the 2023 tax year.
Foundations should determine whether they met the minimum distribution requirement for prior years by the end of the 2023 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.
A foundation’s strategic plan can be invaluable, particularly when determining how to increase the use of any carryforwards.
A private foundation that distributed more than its minimum required distribution in a previous year could have an excess-distribution carryforward, which it must use within five years.
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 it’s set up as a corporation or trust.
This means that 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 their benefit.
Depending on 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, the rules limit how much donors may identify for charitable deductions of 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 fair-market value.
A private foundation may face a liquidity dilemma if it holds a large amount of privately held stock or other non-income producing assets. If the organization holds these assets 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, which would allow the foundation to avoid 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.
The IRS stated that virtual currency is property for tax purposes. However, since there’s no valid charitable deduction without a contemporaneous written acknowledgement, the major issue is likely to be valuation.
IRC Section 170(f)(11)(E)(ii)(I) criteria for a valid deduction requires that the individual have verifiable education and experience in valuing the type of property for which the appraisal is performed.