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Public Policy
Private Foundation Excise Tax
Independent Sector Position
Independent Sector supports reducing the excise tax on investment income of private foundations. The current two-tier system of taxing private foundations discourages foundations from increasing their distributions for charitable purposes.
Background
Under current law, private foundations generally are subject to a 2 percent excise tax on their investment income. The tax is reduced to one percent in any year in which the foundation’s charitable distributions exceed the levels the average level of its distributions over the preceding five years. If a foundation makes a substantial increase in its charitable spending in one year, it raises their five-year average spending to a level they may not be willing to maintain. The foundation then must pay the excise tax rate of 2 percent. As a result of this two-tier structure, private foundations suffer adverse excise tax consequences when they increase their grantmaking in a particular year to respond to a charitable need.
The revenue raised by the excise tax is not being used for its intended purpose—to cover the costs of IRS oversight of exempt organizations. Funding for the IRS Tax Exempt Division is currently below the revenues that would be collected if the excise tax were reduced to a flat one percent of investment earnings.
The Joint Committee on Taxation recommended repeal of the excise tax because of its complexity in its April 2001 report on tax simplification.
In the 107th and 108th Congress, several bills were introduced that would either lower or repeal the excise tax on investment income of private foundations. A proposal to reduce the excise tax was also included in the President Bush’s budget requests for FY03, 04, 05 and 06.
Current Status
The Charitable Giving Act (HR 3908) introduced by Representatives Roy Blunt (R-MO) and Harold Ford (D-TN) in September, 2005 contains a provision that would eliminate the current two-tiered system (1% to 2%) excise tax on private foundation investment income to a flat 2 percent of investment income. Congressional staff have said that this is a drafting error and that the provision will be removed. It is not included in the Senate charitable giving bill, S. 1780, the CARE Act of 2005.
Previous Action
The House of Representatives passed H.R. 7, the Charitable Giving Act of 2003, by a vote of 408 to 13 on September 17, 2003. H.R. 7 would have reduced the excise tax on private foundation investment income from the current two-tiered system (1% to 2%) to a flat 1 percent of investment income. It also included a compromise adopted in the House Ways and Means Committee on the administrative expenditures that private foundations can count towards their annual qualifying charitable distributions. The Committee excluded from qualifying distributions compensation paid to “disqualified persons” (e.g., board members, chief executives, and chief operating officers) in excess of $100,000 per person and air transportation that is not coach-class commercial travel. H.R. 7 also would have raised the excise tax penalties for self-dealing from 5 percent to 25 percent. As introduced, H.R. 7 would have excluded all administrative expenses from qualifying distributions for private foundations.
A provision to lower the excise tax on foundation investment income was not included in the tax provisions of the CARE Act (S. 476) passed by the Senate on April 9, 2003. A conference to resolve differences between the House and Senate bills was not convened before the 108th Congress adjourned in December 2004.
In the 107th Congress, the CARE Act of 2002 (S. 1924), introduced by Senators Lieberman (D-CT) and Santorum (R-PA), contained a provision that would have lowered the excise tax that private foundations pay on net investment income to a single rate of one percent for tax years 2002 and 2003. The provision was not included, however, in the version of the (CARE Act) passed by Senate Finance Committee on June 18, 2002.
The House-passed the Community Solutions Act of 2001 (H.R. 7) would have reduced the two percent excise tax on investment income of tax-exempt private foundations to one percent. (analysis, bill text and cosponsors)
Last updated: December 7, 2005
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