Private foundations and their donors are subject to a host of tax rules and regulations. These rules can sometimes have unexpected and significant negative consequences. As a regular feature of our Tax Updates, we will be offering tips to help you navigate through these rules. Below are a few initial pointers:
1. Contributions of Short-Term Capital Gain Property.
The income tax deduction for a contribution of appreciated property to a private foundation is normally limited to the donor's income tax basis. There is an exception for gifts of publicly-traded securities, which may be deducted based on their fair market value (average of high and low price) on the date of contribution, if those securities are long-term capital gain property. Long-term capital gain property is capital gain property held for more than one year prior to the contribution. Therefore, if you are moving assets from your investment portfolio to your private foundation, be sure to select (if possible) only those marketable securities that you have held for more than a year.
2. Reimbursement of "Disqualified Persons" for Foundation Expenses.
Many of the rules governing private foundations target transactions between the foundation and individuals and entities who have a requisite affinity with the foundation. For example, a substantial contributor to a foundation, and his or her immediate family, employees and controlled entities are "disqualified persons."
Transactions between the foundation and disqualified persons can give rise to substantial excise taxes (if those transactions are "prohibited transactions") and can even jeopardize the foundation's tax-exempt status.
The private foundation rules, with a few limited exceptions, prohibit a foundation from paying a disqualified person for goods or services. For example, if the foundation's principal donor pays for the foundation's legal or accounting fees, and then seeks reimbursement from the foundation, that will be a prohibited transaction. Similarly, if that same donor's spouse buys an accounting software program for the foundation, and is reimbursed for that expense by the foundation, that is a prohibited transaction.
The foundation (and not its donors) should pay its expenses directly from its own funds. If foundation cash flow is a problem, a donor can always make a deductible contribution to the foundation to enable the foundation to pay its bills.
3. Payment of Pledges.
Under the laws of most states (including New Jersey) a written pledge to a charity gives rise to the legal obligation of the pledgor to satisfy the pledge. If a foundation satisfies an individual's pledge, that is tantamount to using foundation funds to pay off an individual's debt. Foundations should never satisfy an individual's pledge (regardless of whether or not that individual is a "disqualified person" as described above). Again, excise taxes may be imposed as a result, and the foundation's tax-exempt status can be jeopardized. Any pledge that the foundation intends to satisfy should be made by the foundation, and not by any individual.
