A foundation that fails to meet the required distribution amounts by the end of the following year is subject to an excise tax of 30% on the undistributed amount, in addition to paying out the undistributed amount. The tax is charged for each year and each future year (or partial year) that the deficiency remains outstanding. Sometimes the Internal Revenue Service will recognize the shortfall and send a notice to the foundation after the return is filed. If this occurs, an additional 100% excise tax is due if the foundation fails to make up the deficiency in distributions within 90 days of receiving this notice. Finally, a termination tax serves as a third-tier tax.
Abating the Penalty Tax
If a private foundation fails to make the required minimum distributions due to a mathematical error in the valuation of its noncharitable use assets, the tax may be abated if the following four criteria are met:
- Failure to value the assets properly was not willful and was due to reasonable cause.
- The deficiency is corrected by the foundation within 90 days of the date of an Internal Revenue Service notice.
- The foundation notifies the Internal Revenue Service of the error by submitting information on its Form 990-PF.
- The distribution made to correct the deficiency is reflected as being made in the deficiency year.
The foundation must prove that the mathematical error was not willful and due to reasonable cause by showing that it made all reasonable efforts in good faith to determine the fair market value of its noncharitable use assets. Any foundation that is seeking an abatement of the penalty tax should file IRS Form 4720 along with an explanation for the abatement of the penalty.
Erring on the Positive Side
On the other hand, a foundation that distributes in excess of the 5% minimum distribution requirement may carry forward the excess up to five future years to fund any year in which there is a shortfall.