Private foundations are entities set up to support charitable, educational, religious, or other activities that benefit the public. They are typically funded by one or more donors, typically individuals, families, or corporations. As a result of their special tax status, private foundations are subject to a unique set of tax rules and regulations. One of the most important of these is the private foundation tax rate.
The first step in determining the private foundation tax charge is to determine the taxable income of the foundation. This includes all income from any source, such as investments, gifts, and grants. Deductions are then subtracted to arrive at net investment income. This is the amount subject to taxation.
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The private foundation tax rate is set at 2%, regardless of the amount of taxable income earned. This rate applies to all private foundations. The rate is set by the Internal Revenue Service and is not subject to change by the individual foundation.
There are two exceptions to the 2% tax rate. The first is the asset test exception. This applies to foundations that have assets of less than $500,000. If the total assets are less than this amount, the tax rate is 1%. The second exception is the expenditure responsibility exception. If a foundation meets certain spending requirements, the tax rate is reduced to 1%. These requirements include spending at least 5% of the foundation’s assets on charitable activities each year.