In addition to proposing new charitable contribution limits, the Obama administration's 2017 fiscal year revenue proposals suggest revamping the two-tiered excise tax system applicable to exempt, private non-operating foundations' net investment income.
Current Law:
A private non-operating foundation that is exempt from federal income tax must nevertheless pay an excise tax on any net investment income that the private foundation earns. Examples of net investment income include income from bonds, stocks, mutual funds and loans. In general, the net investment income is taxed at a rate of 2%.
The private foundation may, however, qualify for a reduced excise tax rate of 1% in any year in which the private foundation's qualifying distributions exceed its average qualifying distributions over the prior five years. Qualifying distributions are, in general, distributions made by the private foundation for charitable purposes.
Under the current system, a private foundation could be at a disadvantage if it drastically increases its qualifying distributions in a given year. While the private foundation would be subject to the lower excise tax rate for that year, going forward, it could be difficult for the private foundation to stay at the lower excise tax rate (given the increase to the five-year average) without increasing its qualifying distributions year after year and spending down its assets.
Proposed Change:
In an effort to simplify the current two-tiered excise tax system, the Obama administration has proposed a single tax rate of 1.35% on a private non-operating foundation's net investment income. This change would be effective for taxable years beginning after the proposal's enactment.
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