Overview of jeopardizing investments
Private foundations are prohibited from using jeopardizing investments, that is, investing their assets in such a manner that risks the foundation’s ability to carry out its charitable intent. Extreme positions and investments that are speculative in nature are not appropriate for foundation investments and may result in excise taxes being levied.
Types of Potentially Jeopardizing Investments That Require Close Scrutiny
- Trading on margin
- Commodity futures
- Working interests in gas and oil
- Puts, calls, and straddles
- Purchase of warrants
- Selling shares short
- Junk bonds
- Risk arbitrage
- Hedge funds
- Distressed real estate
- International equities in third-world countries
Jeopardizing Investment Exceptions
While some types of investments are subject to higher scrutiny, they are not strictly prohibited. Rather, the investment portfolio is viewed as a whole, and specific investments are viewed in relation to the entire portfolio. Foundations that follow prudent investor rules should not have any issues.
Jeopardizing Investment Regulations and Taxes
If a private foundation makes any investments that would financially jeopardize the carrying out of its exempt purposes, both the foundation and the individual foundation managers may become liable for taxes on these jeopardizing investments under section 4944 of the Internal Revenue Code.
Initial tax. An excise tax of 10% of the amount involved (the jeopardizing investment) is imposed on the foundation for each tax year, or part of a year, in the taxable period. The foundation will not be liable for the tax if it can show that the jeopardizing investment was due to reasonable cause and not willful neglect, and that the jeopardizing investment was corrected within the correction period.
An excise tax of 10% of the amount involved is also imposed on any foundation manager who knowingly, willfully, and without reasonable cause participated in making the jeopardizing investment.
This tax applies to investments of either income or principal.
Additional tax. If a private foundation is liable for the initial tax and has not removed the investment from jeopardy within the taxable period, an additional excise tax of 25% of the amount involved will be imposed on the foundation. The additional tax will not be assessed, or if assessed will be abated, if the investment is removed from jeopardy within the correction period.
In each case where this additional tax is imposed on the foundation, an additional excise tax of 10% of the amount involved is imposed on any foundation manager who refuses to agree to all or part of the removal from jeopardy within the correction period.
If more than one individual manager is liable for the excise tax on jeopardizing investments, all parties will be jointly and severally liable.
Limits on liability for management. For any one jeopardizing investment, the maximum initial tax that may be imposed is $10,000, and the maximum additional tax is $20,000.
Foundation Source does not manage assets nor do we provide investment advice about whether an individual investment might be considered a jeopardizing investment, but we work with clients and their advisors to help them fully understand these rules.