Exceptions - taxes on failure to distribute income


The tax does not apply to the undistributed income of a private operating foundation or of an exempt operating foundation.

Certain long-established private foundations that have provided long-term care facilities continuously since May 26, 1969, are treated as private operating foundations and, therefore, are not subject to the excise tax on failure to distribute income.

To qualify for this treatment, the foundation must, on May 26, 1969, and continuously thereafter to the end of the tax year, operate and keep up facilities for the long-term care, comfort, maintenance or education of the permanently and totally disabled, elderly, needy widows, or children as its principal functional purpose. In addition, the foundation must meet the requirements of the endowment test that applies to private operating foundations.

An organization will meet the principal function purpose requirement if it is organized for the principal purpose of operating and maintaining these residential facilities and at least 50% of the qualifying distributions normally made by the organization are spent for the operation and upkeep of these facilities.

These foundations are treated as private operating foundations only for the purposes of the distribution requirements of section 4942 of the Code. All other rules governing nonoperating private foundations, including rules governing deductibility of contributions, apply.

Incorrect valuation of assets.  The tax also does not apply to the undistributed income of a private foundation that failed to distribute only because of an incorrect valuation of assets, if:

  1. The incorrect valuation was not willful and was due to reasonable cause,
  2. The undistributed income is distributed as qualifying distributions during the allowable distribution period,
  3. The foundation notifies the Service that the income has been distributed to correct its earlier failure to distribute, and
  4. The distribution is treated as a correction of deficient distributions for earlier tax years that would otherwise be subject to this tax.

The foundation must be able to show it has made all reasonable efforts in good faith to value its assets according to applicable rules.

If a foundation, after full disclosure of the facts, obtains a bona fide appraisal of an asset's fair market value by a qualified appraiser (whether or not that appraiser is a disqualified person with respect to the foundation), and the foundation relies on that appraisal, then failure to properly value an asset will ordinarily be regarded as not willful and due to reasonable cause. However, if a foundation does not obtain a good faith appraisal, the lack of such an appraisal will not, by itself, imply that the foundation's failure to properly value an asset was willful and not due to reasonable cause.

Example. In 1998 the Martin Foundation, which was established in 1997, incorrectly valued its assets in a manner that was not willful and was due to reasonable cause. As a result of the incorrect valuation, $20,000, which should have been distributed by the end of 1999, is still undistributed as of January 1, 2000. On September 29, 2000, a notice of tax deficiency is mailed to the foundation.

On November 5, 2000, (within the allowable distribution period) the foundation makes a qualifying distribution of $20,000 which is treated as made out of the foundation's undistributed income for 1998. The foundation notifies the Service of its action. Under these circumstances the foundation would have been liable for an initial tax of $3,000 (15% of $20,000). However, because the foundation meets the exception for failure to distribute because of an incorrect valuation of assets, it is not liable for the taxes.

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