26 USC 4942 - Taxes on failure to distribute income

U.S Code last checked for updates: Nov 22, 2024

§ 4942.

Taxes on failure to distribute income

(a)

Initial tax

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)

Additional tax

(c)

Undistributed income

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)

Distributable amount

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)

Minimum investment return

(1)

In general

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)

Valuation

(A)

In general

(B)

Reductions in value for blockage or similar factors

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,

the securities could not be liquidated within a reasonable period of time except at a price less than such fair market value. Any reduction in value allowable under this subparagraph shall not exceed 10 percent of such fair market value.

(f)

Adjusted net income

(1)

Defined

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)

Income modifications

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)

Deduction modifications

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)

Transitional rule

(g)

Qualifying distributions defined

(1)

In general

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)

Certain set-asides

(A)

In general

(B)

Requirements

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)

Certain failures to distribute

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)),

such distribution in cash or its equivalent shall be treated for the purposes of this subparagraph as made during such year.

(D)

Reduction in distribution amount

(E)

Adjustment period

In the case of a set-aside which satisfies the requirements of clause (i) of subparagraph (B), for good cause shown, the period for paying the amount set aside may be extended by the Secretary.

(3)

Certain contributions to section 501(c)(3) organizations

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)

Limitation on distributions by nonoperating private foundations to supporting organizations

(A)

In general

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)

Type I and type II supporting organizations

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)

Functionally integrated type III supporting organizations

(h)

Treatment of qualifying distributions

(1)

In general

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.

For purposes of this paragraph, distributions shall be taken into account in the order of time in which made.

(2)

Correction of deficient distributions for prior taxable years, etc.

(i)

Adjustment of distributable amount where distributions during prior years have exceeded income

(1)

In general

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),

then, for purposes of this section (other than subsection (h)), the distributable amount for the taxable year shall be reduced by an amount equal to such excess.

(2)

Taxable years in adjustment period

(j)

Other definitions

For purposes of this section—

(1)

Taxable period

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)

Allowable distribution period

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)

Operating foundation

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.

Notwithstanding the provisions of subparagraph (A), if the qualifying distributions (within the meaning of paragraph (1) or (2) of subsection (g)) of an organization for the taxable year exceed the minimum investment return for the taxable year, clause (ii) of subparagraph (A) shall not apply unless substantially all of such qualifying distributions are made directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated.

(4)

Functionally related business

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)

Certain elderly care facilities

(Added Pub. L. 91–172, title I, § 101(b), Dec. 30, 1969, 83 Stat. 502; amended Pub. L. 94–455, title XIII, §§ 1302(a), 1303(a), 1310(a), title XIX, § 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1713, 1715, 1729, 1834; Pub. L. 95–600, title V, § 522(a), Nov. 6, 1978, 92 Stat. 2885; Pub. L. 96–596, § 2(a)(1)(C), (2)(B), (3)(B), (4)(A), Dec. 24, 1980, 94 Stat. 3469–3472; Pub. L. 97–34, title VIII, § 823(a), Aug. 13, 1981, 95 Stat. 351; Pub. L. 97–448, title I, § 108(b), Jan. 12, 1983, 96 Stat. 2391; Pub. L. 98–369, div. A, title III, §§ 304(a), (b), 305(b)(4), 314(a)(1), (2), July 18, 1984, 98 Stat. 782–784, 787; Pub. L. 99–514, title XIII, § 1301(j)(6), Oct. 22, 1986, 100 Stat. 2658; Pub. L. 109–280, title XII, §§ 1212(b), 1244(a), Aug. 17, 2006, 120 Stat. 1074, 1107; Pub. L. 110–172, § 11(a)(14)(D), Dec. 29, 2007, 121 Stat. 2485; Pub. L. 113–295, div. A, title II, § 221(a)(105), Dec. 19, 2014, 128 Stat. 4053.)

cite as: 26 USC 4942