Foundation Net Investment Income Tax Rules Get Needed Simplification

Most private foundations will begin paying a lower rate of tax on their net investment income starting this year. On December 20, 2019, President Trump signed into law changes to the private foundation net investment income taxation regime that put into place a flat rate of 1.39 percent.

Private foundations, unlike public charities, are subject to tax on their net investment income under Section 4940 of the Internal Revenue Code. Historically, there was a two-tier tax, with foundations generally being subject to a rate of 2 percent. However, the 2 percent rate could be reduced to 1 percent for any year in which a private foundation could meet the requirements of a complex formula involving the amount of its current distributions, assets, historical distributions and investment income.

This simplifying change to a flat rate is a welcome one in the foundation world, which has advocated for this change for some time. The 1.39 percent rate is effective for tax years beginning after December 20, 2019, which means 2020 for calendar year private foundations. The 1.39 percentage was found by economists to be “revenue neutral,” meaning that the federal government would not gain or lose any revenue as compared to prior law.

For private foundations, net investment income is the excess of gross investment income (interest, dividends, rents and royalties) plus capital gain net income over allowable deductions (expenses incurred in the production or collection of gross investment income or management of property held for production of such income). Click here for more IRS information on the tax.

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