Compliance
The 4940-4945 Rules Every Foundation Family Should Know
Six Code sections that should be on the wall of every private foundation boardroom.
Private foundations operate under a specialized excise-tax regime. The rules cover net investment income, self-dealing, required distributions, excess business holdings, jeopardizing investments and taxable expenditures.
KEY TAKEAWAYS
§4941 self-dealing is broader than ordinary “fairness” intuition.
§4942 creates annual distribution requirements and penalties for failures.
§4943 can matter when founders contribute closely held business interests.
§4944 focuses on prudence in light of the foundation’s charitable needs.
§4945 governs taxable expenditures, including certain grants and political/lobbying expenditures.
§4940 and §4942
For tax years beginning after December 20, 2019, most domestic tax-exempt private foundations subject to §4940 use a 1.39% tax rate on net investment income. For nonoperating foundations, the annual distributable amount is tied to the minimum investment return—generally 5% of noncharitable-use assets after specified adjustments.
Failure to distribute the required amount can trigger a 30% initial excise tax on undistributed income, with a potential additional 100% tax if not corrected after IRS notice.
§4941 and §4943
Self-dealing rules apply to specified transactions between a private foundation and disqualified persons. The analysis is not merely whether the foundation got a “good deal.” Separately, excess business holdings rules generally limit the combined holdings of a foundation and disqualified persons in a business enterprise, subject to detailed exceptions and transition rules.
§4944 and §4945
A jeopardizing investment is evaluated under a prudence standard focused on the foundation’s ability to carry out its exempt purposes. No investment category is automatically prohibited, but the IRS identifies certain speculative practices for careful scrutiny.
Taxable expenditures can include prohibited political activity, certain lobbying, certain grants without required procedures, and expenditures for noncharitable purposes.
FAQ
Can a foundation invest in alternatives?
Potentially, but investment policy, prudence, liquidity, diversification and §4944 analysis matter.
Can a foundation make grants to individuals?
Certain grants can be made if the applicable rules and, when required, IRS-approved procedures are followed.
Can a foundation pay a founder?
Certain reasonable compensation for necessary personal services may be permissible under specific rules, but self-dealing analysis is essential.
Sources and research trail
This page was developed from the source manuscript and should be read with the publication's primary-source library.
- IRS: Tax on net investment income
- IRS: Taxes on failure to distribute income
- IRS: Taxes on excess business holdings
- IRS: Jeopardizing investments defined
- IRS: Taxes on taxable expenditures