A. Introduction

(1) For Section 4940, PPA 2006 makes clear that for taxable years beginning after

enactment, gross investment income includes income (other than unrelated business taxable income (UBTI)) from sources like:

a. Interest,

b. Dividends,

c. Rents,

d. Payments with respect to securities loans (Section 512(a)(5)), and

e. Royalties (including overriding royalties).

(2) The law also changes how capital gains and losses are treated so that all capital

gains and losses (other than UBTI, if applicable) are included in capital gain net income, with a specific exception for like-kind exchanges of related use property. The law also:

a. Prohibits including carrybacks or carryovers of capital losses in computing

capital gain net income.

b. Redefines capital gain net income to include property used to produce gross

investment income. (The Tax Technical Corrections Act of 2007 clarifies that capital gain net income also includes capital gains from appreciation. In determining capital gain net income, capital gain or loss is taken into account except to the extent such gain or loss is taken into account for purposes of the tax imposed by Section 511. See Section 4940(c)(4)(A)).

(3) Calculate net investment income using a series of simple calculations. See the

tables below for the basic formulas to compute the tax.

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(4) Complete the Form 990-PF, Part I to ensure that you include all the appropriate

income and deductions.

(5) Effective for taxable periods beginning after December 20, 2019 the tax rate is

1.39%. However, prior to December 20, 2019 there are several possible tax rates applicable under Section 4940:

a. 0%,

b. 1%, and

c. 2%.

(6) To use a 0% tax rate, a foundation must be a private operating foundation under

Section 4942(j)(3) that meets the requirements, for the tax year in question, of an exempt operating foundation under Section 4940(d).

Note: A foundation must obtain an IRS determination letter recognizing its status as an exempt operating foundation to be exempt from the Section 4940 excise tax. See Rev. Proc. 2024-5, 2024-1 I.R.B. 262 (updated annually).

(7) To use a 1% reduced tax rate, a foundation must meet the requirements of

Section 4940(e) requirements. Complete the Form 990-PF, Parts X, XI, XII, and V to determine eligibility for the reduced rate. This typically requires redoing the Form 990-PF for the prior five years.

(8) If the amount on Part V Line 8 is less than that of Part V Line 7, due to

reclassifying expenses or disqualifying distributions, the foundation is subject to the 2% rate.

(9) The tax is reported on Form 990-PF. Any adjustments to the tax are made to the

Form 990-PF. Use Forms 4621 and 4883 to propose any changes in the Section 4940 tax. Use Form 870-E to secure agreement.

Note: Form 870-E is used with respect to taxes that a taxpayer agrees to pay in full, suspends interest from continuing to accrue, and facilitates closure. See IRM 8.6.4, Reaching Settlement and Securing an Appeals Agreement Form, and IRM 4.70.14, Resolving the Examination.