Private foundations: achieving maximum use of excess qualifying distributions.

• Author: Lerman, Jerry L.

The carryover for excess qualifying distributions presents a planning opportunity that private foundations should use to their advantage.

Distributing Income

A private foundation must make qualifying distributions equal to its "minimum investment return" for any given tax year. In general, its minimum investment return is 5% of the fair market value (FMV) of its investment assets, less the excise tax imposed on its net investment income.

A private foundation has two tax years to make qualifying distributions--the year for which the distributable amount is calculated and the succeeding tax year. If the foundation does not meet this distribution requirement, a 15% tax would be imposed on income remaining undistributed as of the first day of the second (or any succeeding) tax year.

Excess Qualifying Distributions

Qualifying distributions in excess of the year's distributable amount become "excess qualifying distributions" and reduce the distributable amount of any year during the "adjustment period," which is the five tax years following the tax year in which such excess was created. Excess qualifying distributions are applied against the distributable amount after current qualifying distributions. If the foundation has excess qualifying distributions carried forward from more than one tax year, it would use them on a FIFO basis.

When a private foundation continually makes qualifying distributions in excess of its distributable amounts without using the carryover in some manner, it loses an important tax benefit. To avoid this, the foundation may either reduce current distributions and allow more of the carryovers to apply against the current distribution requirement or qualify the foundation as a passthrough or conduit entity.

Use of Carryovers

Using the carryovers by deferring current qualifying distributions may be impractical, because the foundation may not be able to presently carry out its charitable mission. Of course, donors who otherwise would have contributed to the private foundation could provide funds to charities directly. Direct loans to charities by a private foundation are generally discouraged, as they can raise the issue of whether the loan constitutes a qualifying distribution.

Passthrough Approach

The Code provides increased income tax deductions for individuals who make charitable contributions to a private foundation that qualifies as a passthrough or conduit foundation:

* Cash contributions are deductible up to 50% of...