Position The Council on Foundations advocates repeal of the excise tax on private foundation investment income.
Background Generally, private foundations are subject to a 2 percent excise tax on their net investment income. The tax is 1 percent in any year in which the foundation's percentage of distributions for charitable purposes exceeds the average percentage of its distributions over the five preceding taxable years. Generally, private non-operating foundations must make annual distributions for charitable purposes equal to roughly 5 percent of the fair market value of the foundation's endowment assets. The excise tax paid by private investment income-$490 million in 2002-acts as a credit in reducing the 5 percent requirement.
Because the tax paid qualifies as a credit toward the minimum distribution, eliminating the tax would automatically result in an additional $490 million in qualifying distributions per year-about 90 percent of which typically go to grants-according to Internal Revenue Service (IRS) estimates.
The policy presents several problems:
- The revenue raised by the tax is not being used for its intended purpose: to cover costs of IRS oversight of exempt organizations. Instead, while the revenue raised by the tax has steadily increased, the number of IRS audits of private foundations has declined, from 1,200 in 1990 to 191 in 1999. The fiscal 2001 budget of the IRS's exempt-organization division is $58 million.
- Under the current two-tiered structure, a foundation is penalized for making a substantial increase in its charitable spending. Many foundations set spending policies of 5 percent to 6 percent to preserve the long-term value of their endowments. A significant increase in one year (while making them eligible for the 1 percent rate for that year) will increase their five-year average spending percentage to a level they are not willing to maintain. As a result, for the next five years, their tax rate doubles to 2 percent.
- Other tax-exempt organizations are audited but are not subject to a similar excise tax.
The Joint Committee on Taxation (JCT) staff has recommended repeal of the tax. In an April 2001 report ("Study of the Overall State of the Federal Tax System and Recommendations for Simplification," JCS-3-01, Volume 2, pp. 456-459), the JCT agreed with these points and concluded that the tax should be eliminated because of its complexity. Repeal, the report noted, "would relieve private foundations of having to make the necessary calculations of net investment income, file estimated tax returns, and consider the optimal level of charitable activity in terms of the rate of tax."
Legislative History In the 107th Congress, both the House of Representatives and Senate introduced bills to repeal the excise tax. In 2001, Reps. Cliff Stearns (R-FL) and Ways and Means Committee member Phil Crane (R-IL) introduced H.R. 804, which would repeal the excise tax for tax years beginning after 2001. A version of this proposal, providing for a simplification and reduction of the excise tax to 1 percent, was included in H.R. 7, the Community Solutions Act, which passed the House in July 2001. Senators Rick Santorum (R-PA) and Joe Lieberman (D-CT) also included a version of the excise tax in S. 1924, the Charity Aid, Recovery and Empowerment (CARE) Act. However, it was not included in the Chairman's Mark that passed the Senate Finance Committee on June 19, 2002. The Senate was unable to bring the CARE Act to a vote on the Senate floor before the end of the 107th Congress.
108th Status On January 7, Representative Cliff Stearns (R-FL) introduced H.R. 199, a bill to repeal the excise tax for years beginning after December 31, 2003. Reduction of the excise tax was not included in S. 476, the Care Act of 2003, which passed the full Senate by a vote of 95-5 on April 9. However, the House version of the care act, H.R. 7, included a reduction of the excise tax to one percent and passed the house on September 17, 2003. No action has been taken on H.R. 7 or the Care Act since the 108th congress reconvened on January 20, 2004.