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. 

Last updated: February 2, 2009