Private non-operating foundations are required by IRS regulations to make a minimum distribution each year for charitable purposes: roughly 5% of its assets, with certain adjustments, based on the previous year’s assets. (There is no minimum distribution requirement in the founding year.)
Calculating this minimum distribution is complex and includes many components of the foundation’s operations, such as grants, certain administrative expenses, grants repaid or returned to the foundation, cash reserves, tax liability, etc.
For the purposes of this article, the Minimum Distribution Requirement (MDR) is the amount distributed before the end of the foundation’s tax year to avoid the imposition of a penalty for failing to distribute the required amount. Technically, this is what the IRS tax rules call Undistributed Income (UI) for the previous year. For example, what the rules call the 2019 UI is referred to in this article as the 2020 MDR.
If calculated incorrectly, a foundation could inadvertently underpay its required minimum distribution. Should that happen, the foundation may be subject to a 30% penalty on the shortfall amount. To avoid penalties, we strongly recommend that foundations seek out professionals who are intimately familiar with the calculations described here.
Here are the five steps detailed in this article:
1. Calculating the Total Average Annual Value of Foundation Assets
2. Calculating the Cash Reserve
3. Calculating the Adjusted Annual Average Value of Assets
4. Calculating the Minimum Investment Return (MIR)
5. Calculating the Minimum Distribution Requirement (MDR)