The CPA KPA 2025 Tax Planning Guide for Private Foundations

The CPA KPA 2025 Tax Planning Guide for Private Foundations provides valuable information and planning tips to help navigate complex tax and compliance issues. This discussion specifically focuses on private non-operating foundations, also known as grantmaking or family foundations. Here are some important considerations for year-end compliance and annual assessments:

Form 990-PF

Form 990-PF is an annual tax return that private foundations must file with the IRS. This form calculates the excise tax on their net investment income and provides a comprehensive snapshot of the foundation's financial status, including details on grants and other operational activities.

Foundations operating on a calendar year must submit this form by May 15th of the subsequent year. For the 2025 tax year, this means the due date is May 15, 2026. However, if a foundation cannot meet this deadline, it can request an automatic 6-month extension by filing Form 8868, Application for Extension of Time to File an Exempt Organization Return. This extension moves the deadline to November 15, 2026, for calendar-year foundations. Foundations using a fiscal year can also request a 6-month extension, moving their due date accordingly.

Due to the Taxpayer First Act, all private foundations are now required to electronically submit their returns, including Form 990-PF and related forms like Form 990-T (Exempt Organization Business Income Tax Return) and Form 4720 (Return of Certain Excise Taxes), for tax years beginning after July 1, 2019. Paper filings are no longer accepted for these forms.

Consider Donating to the Foundation

Considering a charitable contribution to the foundation offers numerous advantages. Not only does it bolster the foundation's charitable mission, but it also presents potential tax benefits for the donor. Individuals contributing to a private foundation generally qualify for a tax deduction on their individual income tax returns, within the guidelines and limitations set by the IRS.

Tax Deduction Limitations

For contributions to private non-operating foundations, the following percentage limits remain in place for 2025:

• 30% Limitation: Cash contributions to a private foundation are deductible up to 30% of the donor's adjusted gross income (AGI).

• 20% Limitation: Contributions of appreciated assets, such as publicly traded securities or certain other long-term appreciated property, are deductible up to 20% of the donor's AGI.

Any amount exceeding these limitations can be carried forward and deducted in future years for up to five years, after which unused amounts expire.

Why Highly Appreciated Public Securities Are the Best Asset to Contribute

Highly appreciated public securities are particularly advantageous to donate because they allow the donor to avoid paying capital gains tax on the appreciation. The deduction for the donation is based on the fair market value (FMV) of the securities at the time of the gift, rather than the donor's original cost basis (subject to the 20% AGI limitation discussed above). This maximizes the tax benefit while also enabling the foundation to receive the full value of the securities.

In contrast, most other appreciated assets, such as real estate or closely held stock, are generally deductible only up to the donor's cost basis, not the FMV, significantly reducing the potential tax benefit. Additionally, other appreciated assets may require appraisals, incur transaction costs, or involve transfer restrictions, further complicating their donation. Publicly traded securities avoid many of these issues, making them the most efficient and tax-advantaged choice for both the donor and the foundation.

Meeting the 5% Minimum Distribution Requirement

Private foundations must distribute approximately 5% of their assets annually for charitable purposes, known colloquially as the 5% rule. The minimum distribution amount is calculated on Form 990-PF, the annual tax return for private foundations. To verify the distribution amount due by December 31, 2025, refer to Line 6f, Column d in Part XII (Undistributed Income) of the foundation's 2024 Form 990-PF.

The minimum distribution requirement is fulfilled through “qualifying distributions.” Typically, these primarily consist of grants given to public charities but also include any expense incurred to carry out the foundation's charitable mission. Operating expenses, such as payroll and office expenses, generally contribute towards meeting this requirement. Other qualifying distributions include:

• Expenditures on directly operated charitable programs

• The purchase of assets as charitable-use assets

• The acquisition of program-related investments (PRIs)

Private foundations that fail to meet the annual distribution requirement are subject to a punitive excise tax for each year the distribution fails to occur. Excess qualifying distributions, beyond the 5% minimum requirement in a given year, can be carried forward for use in the future for up to five years.

All qualifying distributions are governed by the cash basis method of accounting even if the foundation typically uses the accrual method. This is especially important for grant checks issued near the end of the year. If a grant check is mailed in time to be collected and postmarked by December 31, it counts as a charitable disbursement for that year, regardless of when the recipient deposits the check. Backdating a check does not make it count for a prior year; the mailing date determines its eligibility.

Private foundations can also fulfill the minimum distribution requirement by issuing grants in the form of publicly traded securities. By granting highly appreciated public securities, foundations can avoid paying the 1.39% excise tax on the security’s appreciation and still receive credit for a qualifying distribution based on its FMV. Many large public charities readily accept donations of publicly traded securities. This strategy is particularly useful when the foundation has received a highly appreciated public security as a donation (remember that private foundations assume the donor's cost basis for donated property). The foundation can simply grant the appreciated security to a public charity, bypassing the taxable recognition of gain that would occur if the foundation sold the security.

Verification of Estimated Tax Payments

Private foundations generally need to make estimated tax payments on their net investment income in four equal installments each year. For calendar-year foundations, the due dates for these payments are:

• May 15

• June 15

• September 15

• December 15

Underpayment of any installment can result in penalties, even if the total payments for the year are ultimately sufficient. However, if a foundation's total tax liability for the year is less than $500, no estimated tax payments are required.

Private foundations are strongly encouraged (and in many cases effectively required) to make their federal estimated tax payments electronically, typically through the Electronic Federal Tax Payment System (EFTPS). EFTPS is a secure payment service provided by the U.S. Treasury that allows for online transactions with the federal government. As of late 2023, EFTPS requires multi-factor authentication (MFA) using Login.gov or ID.me credentials.

Excise Tax on Net Investment Income

Private foundations pay a flat excise tax of 1.39% on their net investment income. Net investment income includes interest, dividends, net capital gains (if positive), rents, and royalties, minus any allowable investment expenses. All types of investment income are taxed at this same flat rate, except for income subject to unrelated business income tax (UBIT), which is generally taxed at the standard corporate rate (21% for 2025 under current law).

Private foundations can deduct all ordinary and necessary expenses related to their investments, such as advisory fees paid to portfolio managers and other direct investment costs. However, if an expense is deducted against investment income, it cannot also be used as an exempt charitable expense to meet the 5% minimum distribution requirement.

Capital Gains and Losses

Net capital gains for private foundations are taxed at the same 1.39% excise tax on net investment income. Capital losses can be used to offset capital gains, but they cannot be deducted against other investment income like dividends and interest, nor carried forward to future years. To optimize their tax position, foundations should aim to time the realization of capital losses with the realization of capital gains, allowing the losses to offset the gains effectively.

Before year-end, private foundations should review their investment portfolios to decide whether any capital sales should be made. For example:

If the foundation has excess realized capital losses, it may be beneficial to sell a security with a gain to absorb those losses. The cash from the sale can then be used to repurchase the same or a similar security, resetting the tax basis at a higher level.

If the foundation has excess capital gains, targeted capital loss harvesting can be done to offset those gains.

It is important to note that private foundations are subject to the wash sale rules. A wash sale occurs when a security is sold at a loss and a substantially identical security is acquired within 30 days before or 30 days after the sale date. In a wash sale, the loss is disallowed and cannot be used to offset capital gains. Instead, the disallowed loss is added to the basis of the repurchased securities. Wash sales can be avoided by purchasing a replacement security that is not substantially identical or by simply waiting out the 30-day period to buy back the security.

Unrelated Business Income Tax (UBIT)

Private foundations are subject to the unrelated business income tax (UBIT), which applies to income earned from commercial activities unrelated to the foundation's charitable mission or passive investment activities. Common sources of unrelated business income include:

• Certain alternative investments (hedge funds, private equity, some private partnerships)

• Direct ownership of privately held businesses

• Publicly traded partnerships (PTPs) that report UBTI on Schedule K-1

• Revenue-generating activities such as selling advertising space on a website or publication

Depending on the regulations of the state where the income is generated and where the foundation is located, unrelated business income may also incur state income tax liabilities or necessitate additional state-level filings.

For federal tax purposes, unrelated business taxable income (UBTI) is subject to the general corporate tax rate, which is 21% for 2025 under current law. The foundation must report and pay this tax separately from the 1.39% excise tax on its net investment income.

Rebalancing the Investment Portfolio

Private foundations should regularly rebalance their investment portfolios to maintain their desired mix of assets and risk profile. Since the tax on investment income is just 1.39%, the cost of recognizing gains as part of rebalancing is often relatively low in the big picture.

A good opportunity for rebalancing often arises when foundations sell assets to meet their annual minimum distribution requirements. During this process, it can be efficient to sell holdings that have grown beyond their target allocation, bringing the portfolio back in line with the foundation's long-term goals, risk tolerance, and investment policy statement.

Ensure Books and Records Are Current

Private foundations are required to maintain accurate and up-to-date books and records. However, some foundations without a dedicated bookkeeper may struggle to keep their records current. In such cases, outsourcing accounting to a third-party service provider is a common and straightforward solution.

For foundations managing their own accounting, it is important to:

• Regularly reconcile the cash balance in the books with monthly bank and brokerage statements.

• Before year-end, review whether any checks, expenses, or other transactions were missed or have not cleared.

• Clearly distinguish expenses related to investment management versus charitable activities in the accounting system.

• Further distinguish general grantmaking and administrative expenses from those tied to directly operated charitable programs.

• Where expenses relate to both grantmaking and direct programs, a reasonable allocation method should be used and documented.

Donation Acknowledgment Letters

When a private foundation receives a donation of $250 or more, it must send a written acknowledgment to the donor. As a good year-end practice, the foundation should check and confirm that all necessary donation acknowledgment letters have been correctly issued.

The acknowledgment should generally include:

• The donor’s name

• The date and amount (or description) of the contribution

• A statement indicating whether any goods or services were provided in exchange, and if so, a good-faith estimate of their value

For a more in-depth discussion of the required procedures, please see our article on private foundation donation acknowledgment requirements.

Substantial Contributor Tracking

Private foundations must track substantial contributors, who are generally individuals (or entities) contributing more than $5,000 to the foundation and whose total contributions exceed 2% of the foundation's total lifetime contributions received. When a new substantial contributor is identified, the foundation must report them on its annual tax return (Form 990-PF).

To comply with this requirement, the foundation should implement a system to:

• Track all contributions over the foundation’s lifetime

• Flag potential substantial contributors

• Maintain a separate internal schedule to cross-check with Schedule B and related donor disclosure requirements

Payroll Compliance

Private foundations with paid staff must follow all payroll laws and regulations, just like other for-profit and non-profit employers. Payroll processing companies can be very helpful in ensuring compliance, offering end-to-end assistance. However, the foundation remains responsible for ensuring proper adherence to the rules. At a minimum, foundations should verify that:

• FICA taxes (Social Security and Medicare) are correctly withheld and remitted

• Federal, state, and local income tax withholding is accurate

• Unemployment insurance (FUTA plus applicable state unemployment) is handled correctly

• Worker’s compensation insurance is in place as required by state law

• Any benefits (health insurance, retirement contributions, HSA, etc.) are properly documented and reported

Independent Contractor Payment Compliance

Private foundations must report payments of $600 or more to non-corporate consultants and independent contractors, such as law firms, accounting firms, directors, or trustees. These payments are reported on Form 1099-NEC by January 31 of the following year. Payments to incorporated businesses generally do not require reporting, except for legal services, which must be reported even if the law firm is incorporated.

If a foundation needs to issue only a few Forms 1099-NEC, there are several straightforward options:

• Use Online Filing Services: Specialized websites allow you to prepare and file Form 1099-NEC electronically for a modest fee per form. These platforms typically handle both the IRS filing and distribution of copies to recipients.

• Ask Your Accountant or Tax Preparer: Most accountants and tax preparers are experienced with filing 1099-NEC forms and can handle this task for you, making it convenient (though usually more expensive than doing it yourself online).

• File by Mail: It is still possible to file Form 1099-NEC by mail using IRS-provided scannable forms. However, this approach can be cumbersome, as it also requires submitting Form 1096, the Annual Summary and Transmittal of U.S. Information Returns. Given the extra steps, mailing is generally less efficient than electronic filing.

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