A.6. Example of Section 4940(e) — 0824 Publ 5580 (PDF)

(1) A private nonoperating foundation has assets of $100,000 in the taxable year in

question. Qualifying distributions for the taxable year equal $5,500, and net investment income is $10,000. The data for the base period years are:

Year	Qualifying Distribution	4940(e) Tax Reduction	Assets	4942 Tax
Year 1	$5,000	$0	$100,000	$0
Year 2	$7,000	$0	$140,000	$0
Year 3	$6,100	$100	$100,000	$0
Year 4	$8,000	$0	$120,000	$0
Year 5	$4,000	$0	$100,000	$0

(2) Step 1: Determine if there was liability for tax under Section 4942 for any year in

the base period. Although the percentage for year 5 is less than 5%, no liability was incurred because the foundation carried over excess qualifying distributions under Section 4942(i).

(3) Step 2: Since there was no liability, compute the percentage payout for each

year, as follows:

Year 1: $5000/$100,000 = 5%

Year 2: $7,000/$140,000 = 5%

Year 3: ($6100–$100)/$100,000 = 6%

Year 4: $8000/$120,000 = 6 2/3%

Year 5: $4000/$100,000 = 4%

(4) Step 3: Average the percentage payout figures, with the result in this case being

5.333%.

(5) Step 4: Multiply the 5.333% average payout by the foundation’s assets for the

current year. $100,000 x 5.333% $5,333.

(6) Step 5: Add 1% of the net investment income for the taxable year to this figure.

1% x $10,000 = $100; $100 + $5,333 = $5,433.

(7) Solution: Because qualifying distributions for the taxable year ($5,500) exceed

$5,433, the foundation qualifies for the Section 4940(e) reduction.