• Calculating the MDR incorrectly: Often, return preparers miscalculate the MDR, arriving at a figure much lower than the actual amount. If a foundation fails to meet its MDR in a given year, it will be required to file a penalty return, Form 4720, and will be subject to a 30 percent penalty on the shortfall amount. Moreover, if the penalty is assessed, the foundation will be ineligible to qualify for a reduced excise tax rate for five years.
• Using the accrual method of accounting to show satisfaction of MDR: Treasury regulations mandate that even foundations using this common method of accounting for financial reporting purposes must use cash basis accounting to determine whether a foundation has met its MDR. Using the accrual method could lead to a 30 percent penalty and cause a foundation to become ineligible for the reduced excise tax rate for five years.
• Failing to make estimated tax payments: Larger foundations with even moderate investment income may be required to make quarterly estimated tax payments. Without proper guidance from their preparers, many foundations incur penalties for failure to make these interim payments on time—or at all.
• Failing to track foundation insiders: A private foundation is expected to keep track of all individuals and organizations that are considered insiders (technically, “disqualified persons”). Insiders, who include substantial contributors to the foundation, are prohibited from engaging in financial transactions with the foundation (sales, loans, leases, etc.). Engaging in them may result in a self-dealing violation and penalty. Any insider who engages in a self-dealing transaction is personally responsible for a 10 percent penalty, which may not be forgiven by the IRS even if it is inadvertent, well intentioned and beneficial to the foundation. Preparers often fail to report substantial contributors properly on the annual return and fail to keep track of who is a substantial contributor with respect to the foundation. As a result, a foundation’s board or officers may not realize that certain individuals or companies are considered insiders with respect to the foundation and may permit the foundation to engage in forbidden transactions.
Jeffrey D. Haskell is the chief legal officer for Foundation Source www.foundationsource.com, a provider of comprehensive support services for private foundations.