§4942 — Title 26 Internal Revenue Code | U.S. Code

Summary

Private foundations must pay a tax on money they should have given away but did not. If a foundation still has that undistributed money at the start of the second tax year after it earned it, the foundation owes 30% of the amount left. If any of that money is still undistributed at the end of the taxable period, the foundation owes 100% of what remains. The 30% tax does not apply if the foundation is an operating foundation, or if the only reason it failed to distribute money was a bad asset valuation and the foundation corrects the error, tells the IRS, and pays the amount within the allowed time. When the foundation makes payments, they count first against the prior year’s undistributed income, then the current year’s, then the foundation’s principal, and the foundation can sometimes choose to treat a payment as fixing an earlier year. Short definitions: Undistributed income — the distributable amount minus qualifying distributions. Distributable amount — mainly the minimum investment return plus some other items, minus taxes. Minimum investment return — 5% of the value of assets not used in carrying out the foundation’s work, after certain debts. Qualifying distribution — payments for the foundation’s charitable purposes or buying assets used for those purposes; some set-asides can count if rules are met; some payments to certain supported or controlled organizations do not count. Operating foundation — one that directly spends most of its income on its charitable activities or meets other specified tests. Allowable distribution period — the time allowed to correct a valuation mistake, generally up to 5 years and ending 90 days after an IRS notice unless extended. Taxable period — the time window used to decide whether undistributed income is subject to the tax.

Title 26, §4942

Internal Revenue Code — Source: USLM XML via OLRC

(a)There is hereby imposed on the undistributed income of a private foundation for any taxable year, which has not been distributed before the first day of the second (or any succeeding) taxable year following such taxable year (if such first day falls within the taxable period), a tax equal to 30 percent of the amount of such income remaining undistributed at the beginning of such second (or succeeding) taxable year. The tax imposed by this subsection shall not apply to the undistributed income of a private foundation—

(1)for any taxable year for which it is an operating foundation (as defined in subsection (j)(3)), or

(2)to the extent that the foundation failed to distribute any amount solely because of an incorrect valuation of assets under subsection (e), if—

(A)the failure to value the assets properly was not willful and was due to reasonable cause,

(B)such amount is distributed as qualifying distributions (within the meaning of subsection (g)) by the foundation during the allowable distribution period (as defined in subsection (j)(2)),

(C)the foundation notifies the Secretary that such amount has been distributed (within the meaning of subparagraph (B)) to correct such failure, and

(D)such distribution is treated under subsection (h)(2) as made out of the undistributed income for the taxable year for which a tax would (except for this paragraph) have been imposed under this subsection.

(b)In any case in which an initial tax is imposed under subsection (a) on the undistributed income of a private foundation for any taxable year, if any portion of such income remains undistributed at the close of the taxable period, there is hereby imposed a tax equal to 100 percent of the amount remaining undistributed at such time.

(c)For purposes of this section, the term “undistributed income” means, with respect to any private foundation for any taxable year as of any time, the amount by which—

(1)the distributable amount for such taxable year, exceeds

(2)the qualifying distributions made before such time out of such distributable amount.

(d)For purposes of this section, the term “distributable amount” means, with respect to any foundation for any taxable year, an amount equal to—

(1)the sum of the minimum investment return plus the amounts described in subsection (f)(2)(C), reduced by

(2)the sum of the taxes imposed on such private foundation for the taxable year under subtitle A and section 4940.

(e)(1)For purposes of subsection (d), the minimum investment return for any private foundation for any taxable year is 5 percent of the excess of—

(A)the aggregate fair market value of all assets of the foundation other than those which are used (or held for use) directly in carrying out the foundation’s exempt purpose, over

(B)the acquisition indebtedness with respect to such assets (determined under section 514(c)(1) without regard to the taxable year in which the indebtedness was incurred).

(2)(A)For purposes of paragraph (1)(A), the fair market value of securities for which market quotations are readily available shall be determined on a monthly basis. For all other assets, the fair market value shall be determined at such times and in such manner as the Secretary shall by regulations prescribe.

(B)In determining the value of any securities under this paragraph, the fair market value of such securities (determined without regard to any reduction in value) shall not be reduced unless, and only to the extent that, the private foundation establishes that as a result of—

(i)the size of the block of such securities,

(ii)the fact that the securities held are securities in a closely held corporation, or

(iii)the fact that the sale of such securities would result in a forced or distress sale,

(f)(1)For purposes of subsection (j), the term “adjusted net income” means the excess (if any) of—

(A)the gross income for the taxable year (determined with the income modifications provided by paragraph (2)), over

(B)the sum of the deductions (determined with the deduction modifications provided by paragraph (3)) which would be allowed to a corporation subject to the tax imposed by section 11 for the taxable year.

(2)The income modifications referred to in paragraph (1)(A) are as follows:

(A)section 103 (relating to State and local bonds) shall not apply,

(B)capital gains and losses from the sale or other disposition of property shall be taken into account only in an amount equal to any net short-term capital gain for the taxable year;

(C)there shall be taken into account—

(i)amounts received or accrued as repayments of amounts which were taken into account as a qualifying distribution within the meaning of subsection (g)(1)(A) for any taxable year;

(ii)notwithstanding subparagraph (B), amounts received or accrued from the sale or other disposition of property to the extent that the acquisition of such property was taken into account as a qualifying distribution (within the meaning of subsection (g)(1)(B)) for any taxable year; and

(iii)any amount set aside under subsection (g)(2) to the extent it is determined that such amount is not necessary for the purposes for which it was set aside; and

(D)section 483 (relating to imputed interest) shall not apply in the case of a binding contract made in a taxable year beginning before January 1, 1970.

(3)The deduction modifications referred to in paragraph (1)(B) are as follows:

(A)no deduction shall be allowed other than all the ordinary and necessary expenses paid or incurred for the production or collection of gross income or for the management, conservation, or maintenance of property held for the production of such income and the allowances for depreciation and depletion determined under section 4940(c)(3)(B), and

(B)section 265 (relating to expenses and interest relating to tax-exempt interest) shall not apply.

(4)For purposes of paragraph (2)(B), the basis (for purposes of determining gain) of property held by a private foundation on December 31, 1969, and continuously thereafter to the date of its disposition, shall be deemed to be not less than the fair market value of such property on December 31, 1969.

(g)(1)For purposes of this section, the term “qualifying distribution” means—

(A)any amount (including that portion of reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in section 170(c)(2)(B), other than any contribution to (i) an organization controlled (directly or indirectly) by the foundation or one or more disqualified persons (as defined in section 4946) with respect to the foundation, except as provided in paragraph (3), or (ii) a private foundation which is not an operating foundation (as defined in subsection (j)(3)), except as provided in paragraph (3), or

(B)any amount paid to acquire an asset used (or held for use) directly in carrying out one or more purposes described in section 170(c)(2)(B).

(2)(A)Subject to such terms and conditions as may be prescribed by the Secretary, an amount set aside for a specific project which comes within one or more purposes described in section 170(c)(2)(B) may be treated as a qualifying distribution if it meets the requirements of subparagraph (B).

(B)An amount set aside for a specific project shall meet the requirements of this subparagraph if at the time of the set-aside the foundation establishes to the satisfaction of the Secretary that the amount will be paid for the specific project within 5 years, and either—

(i)at the time of the set-aside the private foundation establishes to the satisfaction of the Secretary that the project is one which can better be accomplished by such set-aside than by immediate payment of funds, or

(ii)(I)the project will not be completed before the end of the taxable year of the foundation in which the set-aside is made,

(II)the private foundation in each taxable year beginning after December 31, 1975 (or after the end of the fourth taxable year following the year of its creation, whichever is later), distributes amounts, in cash or its equivalent, equal to not less than the distributable amount determined under subsection (d) (without regard to subsection (i)) for purposes described in section 170(c)(2)(B) (including but not limited to payments with respect to set-asides which were treated as qualifying distributions in one or more prior years), and

(III)the private foundation has distributed (including but not limited to payments with respect to set-asides which were treated as qualifying distributions in one or more prior years) during the four taxable years immediately preceding its first taxable year beginning after December 31, 1975, or the fifth taxable year following the year of its creation, whichever is later, an aggregate amount, in cash or its equivalent, of not less than the sum of the following: 80 percent of the first preceding taxable year’s distributable amount; 60 percent of the second preceding taxable year’s distributable amount; 40 percent of the third preceding taxable year’s distributable amount; and 20 percent of the fourth preceding taxable year’s distributable amount.

(C)If, for any taxable year to which clause (ii)(II) of subparagraph (B) applies, the private foundation fails to distribute in cash or its equivalent amounts not less than those required by such clause and—

(i)the failure to distribute such amounts was not willful and was due to reasonable cause, and

(ii)the foundation distributes an amount in cash or its equivalent which is not less than the difference between the amounts required to be distributed under clause (ii)(II) of subparagraph (B) and the amounts actually distributed in cash or its equivalent during that taxable year within the correction period (as defined in section 4963(e)),

(D)If, during the taxable years in the adjustment period for which the organization is a private foundation, the foundation distributes amounts in cash or its equivalent which exceed the amount required to be distributed under clause (ii)(II) of subparagraph (B) (including but not limited to payments with respect to set-asides which were treated as qualifying distributions in prior years), then for purposes of this subsection the distribution required under clause (ii)(II) of subparagraph (B) for the taxable year shall be reduced by an amount equal to such excess.

(E)For purposes of subparagraph (D), with respect to any taxable year of a private foundation, the taxable years in the adjustment period are the taxable years (not exceeding 5) beginning after December 31, 1975, and immediately preceding the taxable year.

(3)For purposes of this section, the term “qualifying distribution” includes a contribution to a section 501(c)(3) organization described in paragraph (1)(A)(i) or (ii) if—

(A)not later than the close of the first taxable year after its taxable year in which such contribution is received, such organization makes a distribution equal to the amount of such contribution and such distribution is a qualifying distribution (within the meaning of paragraph (1) or (2), without regard to this paragraph) which is treated under subsection (h) as a distribution out of corpus (or would be so treated if such section 501(c)(3) organization were a private foundation which is not an operating foundation), and

(B)the private foundation making the contribution obtains adequate records or other sufficient evidence from such organization showing that the qualifying distribution described in subparagraph (A) has been made by such organization.

(4)(A)For purposes of this section, the term “qualifying distribution” shall not include any amount paid by a private foundation which is not an operating foundation to—

(i)any type III supporting organization (as defined in section 4943(f)(5)(A)) which is not a functionally integrated type III supporting organization (as defined in section 4943(f)(5)(B)), and

(ii)any organization which is described in subparagraph (B) or (C) if—

(I)a disqualified person of the private foundation directly or indirectly controls such organization or a supported organization (as defined in section 509(f)(3)) of such organization, or

(II)the Secretary determines by regulations that a distribution to such organization otherwise is inappropriate.

(B)An organization is described in this subparagraph if the organization meets the requirements of subparagraphs (A) and (C) of section 509(a)(3) and is—

(i)operated, supervised, or controlled by one or more organizations described in paragraph (1) or (2) of section 509(a), or

(ii)supervised or controlled in connection with one or more such organizations.

(C)An organization is described in this subparagraph if the organization is a functionally integrated type III supporting organization (as defined under section 4943(f)(5)(B)).

(h)(1)Except as provided in paragraph (2), any qualifying distribution made during a taxable year shall be treated as made—

(A)first out of the undistributed income of the immediately preceding taxable year (if the private foundation was subject to the tax imposed by this section for such preceding taxable year) to the extent thereof,

(B)second out of the undistributed income for the taxable year to the extent thereof, and

(C)then out of corpus.

(2)In the case of any qualifying distribution which (under paragraph (1)) is not treated as made out of the undistributed income of the immediately preceding taxable year, the foundation may elect to treat any portion of such distribution as made out of the undistributed income of a designated prior taxable year or out of corpus. The election shall be made by the foundation at such time and in such manner as the Secretary shall by regulations prescribe.

(i)(1)If, for the taxable years in the adjustment period for which an organization is a private foundation—

(A)the aggregate qualifying distributions treated (under subsection (h)) as made out of the undistributed income for such taxable year or as made out of corpus (except to the extent subsection (g)(3) with respect to the recipient private foundation or section 170(b)(1)(F)(ii) applies) during such taxable years, exceed

(B)the distributable amounts for such taxable years (determined without regard to this subsection),

(2)For purposes of paragraph (1), with respect to any taxable year of a private foundation the taxable years in the adjustment period are the taxable years (not exceeding 5) immediately preceding the taxable year.

(j)For purposes of this section—

(1)The term “taxable period” means, with respect to the undistributed income for any taxable year, the period beginning with the first day of the taxable year and ending on the earlier of—

(A)the date of mailing of a notice of deficiency with respect to the tax imposed by subsection (a) under section 6212, or

(B)the date on which the tax imposed by subsection (a) is assessed.

(2)The term “allowable distribution period” means, with respect to any private foundation, the period beginning with the first day of the first taxable year following the taxable year in which the incorrect valuation (described in subsection (a)(2)) occurred and ending 90 days after the date of mailing of a notice of deficiency (with respect to the tax imposed by subsection (a)) under section 6212 extended by—

(A)any period in which a deficiency cannot be assessed under section 6213(a), and

(B)any other period which the Secretary determines is reasonable and necessary to permit a distribution of undistributed income under this section.

(3)For purposes of this section, the term “operating foundation” means any organization—

(A)which makes qualifying distributions (within the meaning of paragraph (1) or (2) of subsection (g)) directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated equal to substantially all of the lesser of—

(i)its adjusted net income (as defined in subsection (f)), or

(ii)its minimum investment return; and

(B)(i)substantially more than half of the assets of which are devoted directly to such activities or to functionally related businesses (as defined in paragraph (4)), or to both, or are stock of a corporation which is controlled by the foundation and substantially all of the assets of which are so devoted,

(ii)which normally makes qualifying distributions (within the meaning of paragraph (1) or (2) of subsection (g)) directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated in an amount not less than two-thirds of its minimum investment return (as defined in subsection (e)), or

(iii)substantially all of the support (other than gross investment income as defined in section 509(e)) of which is normally received from the general public and from 5 or more exempt organizations which are not described in section 4946(a)(1)(H) with respect to each other or the recipient foundation; not more than 25 percent of the support (other than gross investment income) of which is normally received from any one such exempt organization; and not more than half of the support of which is normally received from gross investment income.

(4)The term “functionally related business” means—

(A)a trade or business which is not an unrelated trade or business (as defined in section 513), or

(B)an activity which is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which is related (aside from the need of the organization for income or funds or the use it makes of the profits derived) to the exempt purposes of the organization.

(5)For purposes of this section (but no other provisions of this title), the term “operating foundation” includes any organization which, on May 26, 1969, and at all times thereafter before the close of the taxable year, operated and maintained as its principal functional purpose facilities for the long-term care, comfort, maintenance, or education of permanently and totally disabled persons, elderly persons, needy widows, or children but only if such organization meets the requirements of paragraph (3)(B)(ii).

Notes & Related Subsidiaries

Editorial Notes

Codification section 1212(b) and 1244(a) of Pub. L. 109–280, which directed the amendment of section 4942 without specifying the act to be amended, were executed to this section, which is section 4942 of the Internal Revenue Code of 1986, to reflect the probable intent of Congress. See 2006 Amendment notes below.

Amendments

2014—Subsec. (g)(2)(A). Pub. L. 113–295, § 221(a)(105)(A), substituted “Subject” for “For all taxable years beginning on or after

January 1, 1975, subject”. Subsec. (i)(2). Pub. L. 113–295, § 221(a)(105)(B), struck out “beginning after

December 31, 1969, and” after “(not exceeding 5)”. 2007—Subsec. (i)(1)(A). Pub. L. 110–172 substituted “section 170(b)(1)(F)(ii)” for “section 170(b)(1)(E)(ii)”. 2006—Subsec. (a). Pub. L. 109–280, § 1212(b), substituted “30 percent” for “15 percent” in introductory provisions. See Codification note above. Subsec. (g)(4). Pub. L. 109–280, § 1244(a), amended heading and text of par. (4) generally, substituting provisions relating to limitation on distributions by nonoperating private foundations to supporting organizations for provisions relating to limitation on administrative expenses allocable to making of contributions, gifts, and grants. See Codification note above. 1986—Subsec. (f)(2)(A). Pub. L. 99–514 substituted “(relating to State and local bonds)” for “(relating to interest on certain governmental obligations)”. 1984—Subsec. (a)(2)(B). Pub. L. 98–369, § 314(a)(1), substituted “subsection (j)(2)” for “subsection (j)(4)”. Subsec. (d)(1). Pub. L. 98–369, § 304(b), substituted “the sum of the minimum investment return plus the amounts described in subsection (f)(2)(C), reduced by” for “the minimum investment return reduced by”. Subsec. (f)(1). Pub. L. 98–369, § 314(a)(2), substituted “subsection (j)” for “subsection (d)”. Subsec. (g)(1)(A). Pub. L. 98–369, § 304(a)(2), substituted “including that portion of reasonable and necessary administrative expenses” for “including administrative expenses”. Subsec. (g)(2)(C)(ii). Pub. L. 98–369, § 305(b)(4), substituted “section 4963(e)” for “section 4962(e)”. Subsec. (g)(4). Pub. L. 98–369, § 304(a)(1), added par. (4). 1983—Subsec. (j)(3)(A)(i). Pub. L. 97–448 substituted “or” for “and” at the end. 1981—Subsec. (d)(1). Pub. L. 97–34, § 823(a)(1), struck out “or the adjusted net income (whichever is higher)” after “return”. Subsec. (j)(3). Pub. L. 97–34, § 823(a)(2), (3), inserted in subpar. (A) “the lesser of” after “substantially all of”, designated existing provisions as cl. (i), added cl. (ii), and inserted provision respecting applicability of subpar. (A)(ii). 1980—Subsec. (b). Pub. L. 96–596, § 2(a)(1)(C), substituted “taxable period” for “correction period”. Subsec. (g)(2)(C)(ii). Pub. L. 96–596, § 2(a)(4)(A), substituted “the correction period (as defined in section 4962(e))” for “the initial correction period provided in subsection (j)(2)”. Subsec. (j)(1). Pub. L. 96–596, § 2(a)(2)(B), substituted provision ending the taxable period on the earlier of the date of mailing of a notice of deficiency with respect to the tax imposed by subsec. (a) of this section under section 6212 of this title or the date on which the tax imposed by subsec. (a) of this section is assessed for provision ending the taxable period on the date of mailing the notice of deficiency with respect to a tax imposed by subsec. (a) of this section under section 6212 of this title. Subsec. (j)(2). Pub. L. 96–596, § 2(a)(3)(B)(i), (iii), redesignated par. (4) as (2) and struck out former par. (2), which defined correction period, with respect to any private foundation for any taxable year, as the period beginning with the first day of the taxable year and ending 90 days after the date of mailing a notice of deficiency with respect to the tax imposed by subsec. (b) of this section under section 6212 of this title, extended by any period in which a deficiency cannot be assessed under section 6213(a) of this title and any other period which the Secretary determines is reasonable and necessary to permit a distribution of undistributed income. Subsec. (j)(3)(B)(i). Pub. L. 96–596, § 2(a)(3)(B)(ii), substituted “paragraph (4)” for “paragraph (5)”. Subsec. (j)(4) to (6). Pub. L. 96–596, § 2(a)(3)(B)(iii), (iv), redesignated pars. (5) and (6) as (4) and (5), respectively. 1978—Subsec. (j)(6). Pub. L. 95–600 added par. (6). 1976—Subsec. (a)(2)(C). Pub. L. 94–455, § 1906(b)(13)(A), struck out “or his delegate” after “Secretary”. Subsec. (e). Pub. L. 94–455, § 1303(a), among other changes, substituted provisions establishing a fixed percentage rate to be used in computing the minimum investment return for any private foundation for provisions establishing a variable applicable percentage rate of 7 percent in 1970 and an applicable rate to be determined by the Secretary after 1970, for use in computing the minimum investment return for any private foundation and inserted provisions relating to reduction in value for blockage or similar factors. Subsec. (f)(2)(D). Pub. L. 94–455, § 1310(a), added subpar. (D). Subsec. (g)(2). Pub. L. 94–455, § 1302(a), among other changes, inserted reference to all taxable years beginning on or after Jan. 1, 1975, requirement that the project will not be completed before the end of the taxable year of the foundation in which the set-aside is made, and subpars. (C) to (E). Subsecs. (h)(2), (j)(2)(B). Pub. L. 94–455, § 1906(b)(13)(A), struck out “or his delegate” after “Secretary”.

Statutory Notes and Related Subsidiaries

Amendments

made by this section [amending this section] shall apply to taxable years ending after the date of the enactment of this Act [Oct. 4, 1976].”

Savings Provision

Applicability of section to organizations organized before May 27, 1969, see section 101(l)(3) of Pub. L. 91–172, set out as a note under section 4940 of this title.

§4942 Taxes on failure to distribute income

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