The Pension Protection Act of 2006 (also referred to as H.R.4) includes significant changes that affect charities, generally. The Act also makes certain changes specifically applicable to foundations:
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Private foundations must now exercise "expenditure responsibility" when they make grants to most "Type III" supporting organizations. In general, "Type III" supporting organizations are charities organized to support certain public charities, but which have some organizational and operational distance from the charities they support. "Expenditure responsibility" means that these grants have to be supervised by the granting foundation to confirm that the monies are being appropriately applied. Furthermore, the grants to these Type III supporting organizations do not count toward satisfying the granting foundation's 5% annual distribution requirement. Contributions to Type I or II supporting organizations will be subject to similar restrictions if private foundation insiders ("disqualified persons") directly or indirectly control the supporting organization or its supported organization. These restrictions will have a chilling effect on private foundation grant-making to supporting organizations, since expanded due diligence will be required, and the granting foundation will get no credit toward its 5% annual minimum distribution requirement when it makes grants to these organizations.
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Private foundations have long been subject to a 1% to 2% excise tax on their investment income (previously interest, dividends, rent and royalties). The definition of investment income has now been expanded to include income from "ordinary and routine investments" such as annuities, and capital gains from appreciation on all types of property, including even capital gains from the sale of assets used to further a tax-exempt purpose. There is a limited exception for gains from the sale of assets used in the foundation's tax-exempt purposes if the gain invested is reinvested in like kind property. Loss carry-backs (in addition to loss carry-forwards disallowed under prior law) are now also disallowed.
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Excise taxes on acts of self-dealing have been increased to 10% of the amount involved for the self-dealer, and 5% of the amount involved for foundation managers. The excise tax for failure to distribute the annual minimum from the foundation has been increased to 30% of the undistributed amount. The tax on excess business holdings and jeopardizing investments has been increased to 10%. The excise tax on taxable expenditures has been increased to 20% of the amount of the expenditure.
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Supporting foundations (all types - I, II and III) may not (and this is effective retroactively to July 25, 2006) make grants, loans, compensation or similar payments to substantial contributors and persons in businesses related to a substantial contributor. Similarly, donor-advised funds may not make grants, reimbursements, etc., to the donor, the advisor, or persons or businesses related to them.
These changes will have an immediate effect on many private foundations, and we encourage you to examine the activities of your foundation to confirm that you are in compliance with these new rules.
