Private foundations should be careful to file their tax returns by their due date because the IRS imposes hefty penalties for late filing. In the worst-case scenario, foundations can even lose their tax-exempt status if they completely fail to file tax returns over a multi-year period. There are several distinct penalties for failing to file and for not paying tax on time.
Penalty for Failure to File Timely, Completely, or Correctly
If a private foundation doesn't file a tax return on time or fails to file a complete and correct tax return, it must pay $20 for each day the failure continues ($105 per day for large organizations). The maximum penalty for each return won't exceed the smaller of $10,500 ($54,500 for large organizations) or 5% of the gross receipts of the foundation for the year. The IRS has the power to waive this penalty if the failure was due to a reasonable cause.
As of 2022, a ‘large organization’ is defined as having gross receipts over $1,094,500 for their tax year.
If the IRS believes there is incorrect or missing information relating to a tax return, it may mail a letter to the foundation seeking additional information and an explanation. The IRS can impose a penalty on any responsible person who fails to respond to such an inquiry. Any person who fails to comply with an IRS inquiry for additional information within a reasonable amount of time must pay $10 for each day the failure continues. The maximum penalty imposed on all persons for failing to provide information on any one return is $5,500. The IRS has the power to waive this penalty if the failure was due to a reasonable cause.
If tax returns are filed fraudulently or there is a willful failure to file, the IRS has the option of pursuing criminal charges and can impose criminal financial penalties that are much more severe than those outlined above.
Penalty for Not Paying Tax on Time
The IRS imposes a penalty for not paying tax on time that is distinct from the penalty for failure to file a complete tax return. The penalty for not paying tax on time is imposed on late payments of the net investment income tax as well as the tax on unrelated business income. The penalty is assessed on any outstanding balance that has not been paid by the due date of the foundation's tax return. The penalty is equal to one-half of 1% of the unpaid tax for each month or part of a month the tax remains unpaid. The total penalty cannot exceed 25% of the unpaid tax. The IRS has the power to waive this penalty if the failure to pay tax was due to a reasonable cause.
Estimated Tax Penalties
The rules relating to estimated tax payments for private foundations are generally the same rules that apply to corporations. Private foundations must make estimated tax payments for the excise tax on net investment income and on unrelated business income. The United States has a pay-as-you-go tax system so estimated tax payments must be made as income is earned throughout the year. For calendar year private foundations (the vast majority) the due dates to pay estimated taxes are generally May 15, June 15, September 15 and December 15.
If a foundation’s total tax liability for a year is less $500, no estimated tax payments are required.
If a foundation underpays its estimated tax the IRS assesses a penalty in the form of interest on the underpayment for the period in which the underpayment occurred. Estimated tax penalties are evaluated and calculated separately for each quarterly period. It is therefore possible for a foundation to owe estimated tax penalties even if it has paid enough tax (later in the year) to be due a refund when it files its annual income tax return. The IRS does not have the authority to waive estimated tax penalties for a "reasonable cause" but it will make adjustments for calculation errors and other similar situations.
There are several methods available to private foundations to ensure they pay enough estimated tax throughout the year to avoid penalties. The most common method is the safe-harbor method (not available to large foundations). Under the safe-harbor method, the foundation must make estimated tax payments equal to the total tax from its prior year tax return. The tax payments can be spread out in four equal quarterly installments. This method cannot be used if a foundation’s prior tax year was less than 12 months or the foundation had no tax due on its prior year return.
Interest Assessed on Amounts Owed
In addition to directly assessed financial penalties, the IRS generally charges interest on amounts owed including on financial penalties. Interest increases the amount that is owed until the outstanding balance is paid in full. Each quarter the IRS updates and publishes the current rate of interest—the rate is tied to the federal short-term rate plus a constant margin. It is very rare for the IRS to waive or abate interest on amounts owed.
Criteria For Penalty Relief
Under certain circumstances a private foundation can petition the IRS to waive penalties for failing to file a complete tax return and for not paying tax on time. The petition should include a reasonable cause explaining why the foundation did not comply with the requirements of the law. The IRS is much more likely to waive the penalties if a foundation made an effort to comply but was unable to meet its obligations due to circumstances beyond its control (e.g., the sudden and unexpected death of the employee responsible for compliance). While the IRS does occasionally waive financial penalties, it only rarely abates interest on outstanding balances.
Revocation of Tax-exempt Status
Private foundations are required to file an annual Form 990-PF with the IRS. If a private foundation fails to file an annual return for three consecutive years, it will automatically lose its tax-exempt status. A private foundation that loses its exemption is still legally obligated to file income tax returns and pay income taxes for the delinquent years. If the organization continues to exist after losing its tax-exemption it must still annually file Form 990-PF as a taxable private foundation.
