When forming a nonprofit organization, at some point founder have to weigh the merits of the public charity versus the private foundation. Both are classified by the IRS as 501(c)(3)s. There are indeed benefits and challenges to the structure of both nonprofits, but private foundations can be subject to stricter oversight and need to meet different requirements to retain compliance. Because all the different aspects of a private foundation can be difficult to parse out together, it’s helpful to break it down. We’ve covered self-dealing and now it’s time to explore the payout requirement for private foundations.
Qualifying Distributions
Unlike public charities, private foundations are required to spend a minimum amount—called a qualifying distribution—for grants, administration, and other charitable distributions every year, or pay a penalty. The amount of the qualifying distribution is equal to 5% of the fair market value of the foundation’s assets during that year.
The following are considered permissible for qualifying distribution payments:
- Grants
- Costs of all direct charitable activities
- Program-related investments and loans
- Administrative expenses necessary for the conduct of its charitable activities
- Asset purchases for carrying out charitable activities (such as furniture or computers)
- Program-related investments and loans
If a private foundation fails to make a qualifying distribution, the IRS imposes a hefty penalty (a 30% excise tax) on the funds a private foundation fails to distribute.
The More You Know
An important caveat to the qualifying distribution requirements is that a foundation may elect to set aside funds for up to 5 years for certain major projects. Furthermore, excess qualifying distributions may be carried forward for a period of five tax years immediately following the tax year in which the excess was created.
Leader Liability
Foundation managers should be aware that while the penalty is imposed on the foundation, individuals may also be charged penalties on the grounds s/he failed to exercise fiduciary duties.
Let a Lawyer Help
With all of that said, this is why it’s a smart (even essential) idea to enlist an attorney well-versed in the intricacies of nonprofit law to serve as a guide at different steps throughout the life cycle of a private foundation, from formation to board building, to continued compliance.
Questions? Want to learn more about how to make certain your private foundation is set up for success from the start? Don’t hesitate to contact me for a free consultation. You can also download my free, no-obligation nonprofit formation guide!
