Fiscal year 2025 budget proposal contains items affecting exempt organizations

ARTICLE | March 21, 2024

Authored by RSM US LLP

Executive summary: Budget proposal again includes items affecting certain exempt organizations

The Biden administration released its fiscal year 2025 proposed budget, which includes several items that would directly affect tax-exempt organizations, particularly donor advised funds (DAFs) and private foundations. For a complete discussion of the budget proposal, see the RSM article.

Focus on permissible distributions

As explained in the Treasury Department’s Greenbook, two proposals would preclude private foundations from utilizing certain grants to donor advised funds (DAFs) and certain payments to disqualified persons to satisfy the annual five percent payout requirement.

Grants to DAFs

The Administration proposes amending the definition of a qualifying distribution for payments made by a private foundation to a DAF. Specifically, the Administration’s proposal would permit a private foundation to claim a qualifying distribution for a grant made to a DAF only when (1) the DAF expends such funds as qualifying distributions by the end of the following taxable year; and (2) the private foundation maintains adequate records showing that the DAF made the qualifying distribution within the required timeframe.

Current law does not limit a private foundation’s ability to make grants to a DAF in satisfaction of the annual payout requirement. In addition, current law does not impose a minimum payout requirement on DAFs. Therefore, some private foundations may make distributions to DAFs in satisfaction of their annual distribution requirement even though the dollars are not currently being used for charitable purposes. The IRS currently gathers information about foundations that generally utilize DAFs on Form 990-PF, Part VI-A, Line 12, which asks whether the private foundation made a distribution to a DAF over which the foundation or a disqualified person had advisory privileges.

The Administration’s proposal would appear to treat private foundation distributions to DAFs similar to how current law treats private foundation distributions to other private foundations by requiring the grantee to redistribute the funds as qualifying distributions by the end of the following taxable year in order for the grantor private foundation to treat the grant as a qualifying distribution.

Payments to disqualified persons

The Administration proposes further amending the definition of a qualifying distribution to exclude payments of compensation or reimbursement of expenses by a private foundation to a disqualified person (other than a foundation manager who is not a member of the family of any substantial contributor).

Current law permits private foundations to claim qualifying distributions for reasonable and necessary administrative expenses paid by the foundation to further its charitable purposes, including the payment of compensation to a disqualified person. The Greenbook notes that some private foundations meet their entire payout requirement by hiring family members, defeating the intent of the provision, which is to utilize foundation assets for charitable purposes, such as making grants to needy persons or operating charities.

RSM US Takeaway

These items were also included in the fiscal year 24 proposed budget but have not seen significant progress toward enactment. If adopted, the proposals would require private foundations to reevaluate the treatment of these types of expenditures as qualifying distributions and update current practices and policies to ensure that the foundation continues to meet its annual minimum distribution requirement.

Other items affecting exempt organizations

Also noteworthy is the proposed increase in the corporate income tax rate from 21% to 28%. The majority of exempt organizations are structured as corporations and pay income tax on their unrelated business income at regular corporate rates. Those subject to the section 4960 excise tax on excess executive compensation are also taxed at the prevailing corporate rate.

For those exempt organizations structured as trusts, the proposed increase to the top individual tax rate from 37% to 39.6% would also affect their unrelated business income tax liability, as trusts are generally taxed at individual tax rates.