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Section 4940 imposes an excise tax on the net investment income of most domestic tax-exempt private foundations, including private operating foundations. On December 20, 2019, new legislation was signed that changed the excise tax rates of net investment income for most domestic tax-exempt private foundations, including private operating foundations. For tax years beginning Jan. 1, 1985 through Dec. 20, 2019, the excise tax was 2% of net investment income, but was reduced to 1% in certain cases.Effective for tax years beginning after Dec. 20, 2019, Section 4940(a) was amended to use a single tax rate of 1.39% on net investment income and Section 4940(e) was repealed. For tax years beginning after Dec. 20, 2019, all private foundations subject to the Section 4940 excise tax on net investment income will calculate the tax using the 1.39%.A private operating foundation can avoid the excise tax on net investment income if it meets the criteria to be an exempt operating foundation.

Section 4940(d), added by The Deficit Reduction Act of 1984, is effective for taxable years beginning after December 31, 1984. According to the legislative history of Section 4940, Congress believed that private operating foundations which have substantial public involvement and are not controlled by disqualified persons should be exempt from the excise tax on net investment income, and that other foundations making grants to such organizations should not be required to comply with the expenditure responsibility rules in Section 4945. The changes were intended to assist such public-involvement operating foundations in making direct expenditures for the active conduct of their charitable activities. See Staff of the J. Comm. On Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 670-671 (JCS-41-84).Section 4940(d) provides that a private foundation that qualifies as an exempt operating foundation under Section 4940(d)(2) for the taxable year is exempt from the excise tax on net investment income imposed by Section 4940(a). Section 4940(d) also explains that the term "exempt operating foundation", with respect to any taxable year, applies to any private foundation if:

Operating Foundation: The first requirement is that the organization qualify as a private operating foundation as defined in Section 4942(j)(3). Generally, that means the foundation devotes most of its resources to the active conduct of its exempt activities.Publicly Supported: Section 4940(d)(3)(A) provides that a private foundation is publicly supported for a taxable year if it meets the requirements of Section 170(b)(1)(A)(vi) or Section 509(a)(2) for such taxable year. A foundation is publicly supported if it normally receives a substantial part of its support from governmental units or from direct or indirect contributions from the general public, or the foundation both normally receives more than a third of its support from governmental units, certain publicly supported charities, and persons other than disqualified persons, in gifts, grants, contributions, membership fees, and gross receipts from activities that are not an unrelated trade or business, and does not normally receive more than a third of its support from gross investment income plus any excess of unrelated business taxable income over the tax on unrelated business income.Governing Body: Section 1.170A-9(f)(3)(v) provides that the governing body of the organization may be considered to represent a broad interest of the public if it is composed of persons having special knowledge or expertise in the particular field or discipline in or appointed officials, clergymen, educators, civic leaders, or other such persons representing a broad cross-section of the views and interests of the community.Disqualified Individual: For purposes of Section 4940(d), a "disqualified individual" means an individual who is a substantial contributor to the foundation (as defined in Section 507(f)(2)); an individual described in Section 4946(a)(1)(C) (relating to 20 percent ownership in a corporation or enterprise that is a substantial contributor); or a member of the family of either of the above. The term "disqualified individual" is narrower than "disqualified person" because it does not include foundation managers, exempt organizations, or nonexempt organizations.

Section 4942(j)(3) Private Operating FoundationYour organization has a determination letter from the United States Internal Revenue Service that designates the organization as exempt from federal income tax under section 501(c)(3). The organization is further defined as a private operating foundation under sections 4942(j)(3) and 509(a) because it devotes most of its resources to the active conduct of its exempt activities (as opposed to simply making grants).

Section 4940(d)(2) Exempt Operating FoundationYour organization has a determination letter from the United States Internal Revenue Service that designates the organization as exempt from federal income tax under section 501(c)(3). The organization is further defined as an exempt operating foundation within the meaning of section 4940(d)(2). 041b061a72