By Stephen D. Candelario, CPA, Shareholder
Following the reopening of the IRS in July 2020, high-income earners and private foundations have been under the IRS’s lens in an effort to recover back taxes owed by these groups. Treasury Secretary Steven Mnuchin reported that the IRS would be looking to audit these groups back in March 2020, in an effort to recover taxes from high-income non-filers and interrupt self-dealing in private foundations.
This focus on private foundations is a reminder to review your private foundation’s financial situation regularly and work with a CPA to ensure your books are in order. Without consistent check-ups, your foundation could face significant tax penalties. Here are some best practices for tax savings and common pitfalls for private foundations, as well as how to avoid a self-dealing audit from the IRS.
Best practices for tax savings for private foundations
All private foundations must file a 990-PF with the IRS annually (typically by May 15 for the previous calendar year), but this isn’t an ordinary tax form. The 990-PF can present significant tax saving opportunities if prepared by an experienced professional or cause severe scrutiny and lead to penalties if not properly filed. Here’s how you can optimize your 990-PF for tax savings:
- Know what counts toward MDR – Don’t waste your funds to avoid shortfalls. The minimum distribution requirement (MDR) can be satisfied by more than just grants. Legitimate administrative expenses qualify, and an experienced tax preparer can help you determine what these are.
- Offset investment income with investment-related expenses – This small, but often overlooked, tip can help lower your tax bill.
- Satisfy future year’s MDR with banked excess grants – If your foundation grants more than your MDR, you could carry over the excess grants and apply them to your MDR within the next five years.
Common financial pitfalls facing private foundations
As mentioned, improper handling of the 990-PF can also create costly challenges for private foundations. Here are some of the common pitfalls to avoid:
- Mishandling or miscalculating your MDR – Failing to meet your MDR through miscalculations or using an accrual method of accounting rather than a cash basis can result in a 30% penalty for each from the IRS. Additionally, using an accrual method can result in your foundation’s ineligibility for the reduced excise tax rate for five years.
- Missing or failing to make estimated tax payments – This can result in penalties.
- Failing to track and disclose foundation insiders – Your private foundation is required to track insiders or disqualified persons as they could open you up to self-dealing penalties.
Be mindful of self-dealing in your private foundation
Self-dealing in private foundations is when a foundation insider or disqualified person such as an officer, trustee, or relative of such, or a government official engages in financial transactions with the foundation. The rules regarding self-dealing are all-encompassing and strictly enforced by the IRS. Transactions considered self-dealing include:
- Sales, exchanges, or leases of property
- Money lending or credit extensions
- Providing goods, services, or facilities
- Payments related to compensation or expense reimbursement
- Transferring or use of income or assets of the private foundation to the benefit of the disqualified person
- Payment of government officials
Even if the action was inadvertent, well-intentioned, and beneficial to the foundation, self-dealing could result in a personal 10% penalty that may or may not be forgiven. Here’s how to avoid a self-dealing penalty:
- Do not accept non-cash gifts with a mortgage or lien.
- Do not satisfy pledges of founders or disqualified persons using foundation grants.
- Do not make advances to foundation managers of more than $500 for reasonable expenses or duties.
- Document operating arrangements thoroughly.
- Disclaim membership privileges provided by grantees for grants made. Privileges can be passed to employees who are not disqualified persons, but disqualified persons must pay their own memberships.
- Avoid joint arrangements between the foundation and a disqualified person to pay for benefit event tickets, and do not pay for tickets of spouses of disqualified persons unless there is a business reason.
- Avoid vendors with entities controlled by the private foundation or a disqualified person.
Private foundations should work with an experienced CPA that specializes in their unique and complex tax needs. Don’t be surprised or caught off guard by an IRS audit. Reach out to us for assistance with your private foundation.