Over the years, we have examined thousands of tax returns of private foundations, filed before becoming Foundation Source clients. What we have found is that many tax practitioners are unfamiliar with the nuances of the form, which is highly specialized. They therefore may miss important opportunities for the foundation and unknowingly subject the foundations to scrutiny.

Missed Opportunities for Savings

Not Counting Administrative Expenses

Some preparers are under the misconception that only grants will satisfy a foundation’s minimum distribution requirement (MDR). In fact, legitimate administrative expenses count toward the satisfaction of the MDR, and not counting them can cause a foundation to scramble, making hasty grants (and perhaps wasting funds) in order to avoid a shortfall penalty. A better understanding of qualifying expenses can maximize the funds available for planned, strategic grantmaking.

Not Using Investment-Related Expenses to Offset Investment Income

Frequently, return preparers fail to apply investment-related expenses to offset the investment income, resulting in a higher tax bill for the foundation.

Failing to determine eligibility for the reduced 1% tax rate

The excise tax on net investment income for private foundations has historically been a default rate of 2%, with the possibility of reducing such rate to 1% where certain distribution requirements are met. Although recent legislation has simplified the excise tax rate to a flat rate of 1.39% for tax years beginning after 12/20/2019, it is important to ensure that the section for determining eligibility for the 1% rate is completed on all returns for tax years beginning prior to such date. Based on our experience, preparers often fail to complete this part of the return altogether!

Failing to Properly Calculate Excess Grant Carryover

For any year in which a foundation grants significantly more than its MDR, the excess grants may be “banked” as grant carryover to help satisfy a future year’s MDR. The carryovers expire if not applied toward the foundation’s MDR within five years. When preparers calculate and apply carryovers incorrectly, the damage isn’t limited to a lost opportunity.

Miscalculations actually place the foundation’s true MDR in doubt and create the false and dangerous impression that the foundation has satisfied its MDR when it has not. Correction may require filing several years’ worth of amended returns.