The Private Foundation Excise Tax is a federal tax imposed on certain private-foundation activities. The routine annual tax under IRC Section 4940 applies to net investment income. For most domestic private foundations, the rate is currently 1.39%.
Net investment income can include interest, dividends, rents, royalties and capital gains, after allowable expenses associated with producing that income. Private foundations may also face separate penalty excise taxes when they violate specific private foundation rules, including restrictions involving self-dealing, required distributions, business holdings, certain investments and taxable expenditures. These additional taxes can be substantially larger than the regular investment-income tax.
The key distinction in private foundation vs public charity classification is generally where financial support comes from and how the organization operates. Private foundations are commonly funded by one individual, family or company, while public charities typically receive broader public support or conduct qualifying public programs.
Because private foundations may have more concentrated funding and control, federal tax law subjects them to additional restrictions and excise taxes. These rules govern areas such as transactions with donors and family members, annual distributions and investment activity. This distinction is separate from the broader Nonprofit vs For-Profit question because both private foundations and public charities are nonprofit entities.
Private foundations may encounter several different excise taxes. IRC Section 4940 imposes the regular 1.39% tax on net investment income. Sections 4941 through 4945 establish additional taxes for prohibited activities.
These include self-dealing with certain donors, managers or related parties; failing to make required annual distributions; holding excessive interests in business enterprises; making investments that jeopardize the foundation’s charitable purpose; and making certain taxable expenditures.
Initial penalties vary by violation and can increase significantly when an issue is not corrected. For example, an undistributed amount can initially face a 30% excise tax, with an additional tax if the deficiency remains unresolved.
The enacted One Big Beautiful Bill Act did not change the current 1.39% tax on private-foundation net investment income. Earlier House legislation had proposed replacing the flat rate with graduated rates of 1.39%, 2.78%, 5% and 10% based on foundation asset levels.
That tiered structure did not become the applicable 2026 rule. Most domestic private foundations therefore continue to pay a flat 1.39% rate under IRC Section 4940.
The current rate itself dates to 2020. Before then, foundations generally paid either 1% or 2%, depending partly on their qualifying charitable distributions. The 1.39% rate replaced that two-tier structure.
A private foundation generally begins by calculating net investment income. This includes items such as interest, dividends, rents, royalties and net capital gains, together with certain income unrelated to its charitable purpose. Ordinary and necessary expenses directly connected with producing that investment income may generally reduce the taxable amount.
The resulting net investment income is generally multiplied by the 1.39% excise-tax rate.
The foundation reports its investment activity and excise-tax calculation annually on Form 990 pf. The form also tracks charitable disbursements and calculations related to the foundation’s annual distribution requirement. Estimated tax payments may be required when expected tax reaches applicable thresholds.
A private foundation is a separate charitable organization with its own governance, annual tax filings and compliance obligations. A donor-advised fund is generally an account maintained by a sponsoring charity. The key difference is that a private foundation is a separate legal entity, while a DAF is established within an existing charitable organization.
Yes. Net investment income generally includes net capital gains along with interest, dividends, rents and royalties. Certain ordinary and necessary expenses related to producing investment income can reduce the taxable amount, subject to the applicable tax rules.
Not under the current 1.39% rate structure. Before 2020, qualifying distributions could affect whether a foundation paid a 1% or 2% rate. Today, qualifying distributions remain important for satisfying the separate annual distribution requirement rather than reducing the 1.39% rate.
Private foundations generally calculate a required annual distribution based on approximately 5% of qualifying investment assets. Excess qualifying distributions may generally be carried forward for up to five years. Charitable Contributions by donors are governed by separate rules from the foundation’s distribution requirement.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Bennett Thrasher’s nonprofit accounting practice, or call us at 770.396.2200.
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