Private Foundation Tax - Understanding Excise Tax in a 990-PF Return: How It Applies to Investment Income
Private foundations operate under unique tax rules, particularly when it comes to excise tax on investment income. If you’re a tax professional assisting foundations with their Form 990-PF, understanding how excise tax applies to capital gains, interest income, and dividend income is crucial. In this post, we’ll break down the key points you need to know.
What Is the Excise Tax on Investment Income?
Private foundations are subject to an excise tax on their net investment income under IRC Section 4940. This tax helps fund the oversight of tax-exempt organizations and ensures that private foundations contribute to public purposes.
As of 2020, the excise tax rate on net investment income is a flat 1.39%, replacing the previous two-tiered system of 1% or 2%.
How Is Excise Tax Calculated on Investment Income?
The excise tax is imposed on a foundation’s net investment income, which includes:
Interest income
Dividend income
Net capital gains (both long- and short-term)
Other investment-related income
Deductions allowed against this income include expenses incurred in earning investment income, such as investment advisory fees, certain taxes, and depreciation on investment property.
Capital Gains and Excise Tax in a 990-PF
Private foundations must report both long-term and short-term capital gains on Form 990-PF, Part IV. However, only the net realized capital gains are subject to the 1.39% excise tax. Unrealized gains and losses (such as those from securities still held at year-end) do not factor into the excise tax calculation.
The tax applies to all capital gains, whether they come from sales of stocks, bonds, real estate, or other investments. Additionally, capital losses can offset gains, reducing the taxable amount.
Interest and Dividend Income in a 990-PF
Interest Income: This includes taxable interest earned from investments such as bonds, savings accounts, and other fixed-income instruments.
Dividend Income: All taxable dividends received from stock investments must be reported, regardless of whether they are qualified or non-qualified dividends.
Both types of income are subject to the 1.39% excise tax, with deductions allowed for directly related expenses.
Key Reporting Sections on Form 990-PF
Part I, Column (c) – Reports total revenue, including taxable interest, dividends, and net capital gains.
Part IV – Details capital gains and losses.
Part VI, Line 5 – Calculates the net investment income, which is used to determine the excise tax owed.
Part V, Line 8 – Reports the excise tax liability on investment income.
Final Thoughts
Understanding how excise tax applies to capital gains, interest, and dividends is essential for private foundations and their tax professionals. By correctly reporting income, applying allowable deductions, and computing the 1.39% tax rate, foundations can remain compliant while minimizing their tax liability.
Need assistance with Form 990-PF? Contact Baker Business and Tax Services, who is experienced in filing returns for private foundations, to ensure accurate reporting and compliance.