2012-02-22 Tax Private Foundation Investments

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  • How many publically held stocks are there in the US?What index do you have if you took all the roughly 3000 stocks?What index do you have if you just took the top 1000What index do you have if you just took the bottom 2000Large growth?All cap value? Etc.Why did harry markowitz segment the market along size and relative value/strength dimensions? Those are the systemic/reliable risks that drive investment returns. The smaller and the weaker – the higher the expected return and the and higher the risk of loss and volatility.The stocks in each class share common return and volatiliity expectations because of their common size and relative strength or weakness. Show risk premiums slides.
  • Your portfolio benchmark should account for the risk inherent in your portfolio.This illustrates some of the common indexes used to benchmark investments. The percentages reflect approximately a market neutral portfolio in terms of exposure to large, small, value, growth, international, and emerging – as well as the various bond segments.
  • 2012-02-22 Tax Private Foundation Investments

    1. 1. Taxation of Investments for Private Foundations Frank H. Smith, Partner & Dennis Gogarty, Raffa Wealth Management February 22, 2012Thrive. Grow. Achieve.
    2. 2. NET INVESTMENT INCOMETaxation of Investments / Page 2
    3. 3. NET INVESTMENT INCOME • Capital losses from the sale of foundation investments can only be used to offset capital gains in the same tax year. They cannot be used to offset other investment income, nor can they be carried back or forward to other tax years. • When possible, foundation managers and investment advisors should manage the sale of such investments to avoid large losses in one year and large gains in another year.Taxation of Investments / Page 3
    4. 4. NET INVESTMENT INCOME • A foundation can qualify for a reduced tax rate of 1% if it makes qualifying distributions during a tax year that is at least equal to a certain amount that is based on the average percentage of assets distributed in the prior five tax years. • A private foundation does not qualify for the 1% rate in it’s first year. For the second through fourth years, the average is calculated for the period of time the foundation has been in existence.Taxation of Investments / Page 4
    5. 5. NET INVESTMENT INCOME • The 1% rate is not available if a private foundation was liable for tax under the mandatory payout rules with respect to any year in the measuring period.Taxation of Investments / Page 5
    6. 6. QUALIFYING DISTRIBUTIONSTaxation of Investments / Page 6
    7. 7. QUALIFYING DISTRIBUTIONS • Private foundations often receive highly appreciated stock from its donors. Sale of such appreciated property would normally generate net investment income that is taxable to the foundation. • If a foundation contributes appreciated property to a public charity, the foundation gets a qualified distribution for the full fair market value of the property, but does not have to pay taxes on the amount of the appreciationTaxation of Investments / Page 7
    8. 8. PROGRAM RELATED INVESTMENTSTaxation of Investments / Page 8
    9. 9. PROGRAM RELATED INVESTMENTS AMOUNTS PAID TO ACQUIRE OR OPERATE PROGRAM-RELATED INVESTMENTS ARE TREATED AS QUALIFYING DISTRIBUTIONS FOR SATISFYING THE MINIMUM DISTRIBUTION REQUIREMENTS. IT IS NOT CLASSIFIED AS A JEOPARDIZING INVESTMENT. • A program-related investment should possess the following characteristics: ̵ Primary purpose is to accomplish a charitable, educational, or similar purpose ̵ Production of income or appreciation of property is not a significant purpose of the investment ̵ Investment is not made in order to influence legislation or campaign on behalf of a candidate for public officeTaxation of Investments / Page 9
    10. 10. PROGRAM RELATED INVESTMENTS EXAMPLES OF PROGRAM RELATED INVESTMENTS INCLUDE: • Low-interest or interest-free loans to needy students. • High-risk investments in nonprofit low-income housing projects. • Low-interest loans to small business owned by members of economically disadvantaged groups, where commercial funds at reasonable interest rates are not readily available. • Investments in businesses in deteriorated urban areas under a plan to improve the economy of the area by providing employment or training for unemployed residents. • Investments in nonprofit organizations combating community deterioration.Taxation of Investments / Page 10
    11. 11. JEOPARDIZING INVESTMENTSTaxation of Investments / Page 11
    12. 12. JEOPARDIZING INVESTMENTS • While the IRS has noted that it will not consider any type of investment a “jeopardizing investment” per se, there are certain categories of investments that it will closely scrutinized, such as puts, calls, warrants, etc. An investment would be considered to be a jeopardizing investment if the foundation managers, in making the investment, fail to exercise ordinary business care in providing for the long and short-term financial needs of the foundation.Taxation of Investments / Page 12
    13. 13. JEOPARDIZING INVESTMENTS • An initial tax of 5% is imposed for making the investment. The IRS has discretionary authority to reduce this initial tax. • The taxable period is the period beginning with the date on which the amount is invested in a jeopardizing manner and ending on the earliest of the following dates: ̵ Date on which the IRS mails a notice of deficiency with respect to the initial tax imposed on the foundation. ̵ Date on which initial tax is assessed, or ̵ Date on which the amount invested is removed from jeopardy.Taxation of Investments / Page 13
    14. 14. EXCESS BUSINESS HOLDINGSTaxation of Investments / Page 14
    15. 15. EXCESS BUSINESS HOLDINGS • Generally, excess business holdings would exist if a private foundation and all disqualified persons combined own over 20% of the voting stock of an incorporated business enterprise. Under certain circumstances, this percentage may increase to 35%. In addition, there is a 2% de minimis rule in situations where the foundation itself owns 2% or less of both the voting stock and value of all outstanding shares of the business enterprise. There is also a 5-year grace period for business holdings that are obtained through gift or bequest.Taxation of Investments / Page 15
    16. 16. DISQUALIFIED PERSONS • Disqualified persons are individuals or organizations a private foundation is deemed to be related to and with which the private foundation is limited from engaging in transactions which may create self-dealing or excess business holding issues (discussed below).Taxation of Investments / Page 16
    17. 17. DISQUALIFIED PERSONS DISQUALIFIED PERSONS INCLUDE THE FOLLOWING: • Officers, directors or trustees of the foundation • A substantial contributor to the foundation • Companies or partnership substantially owned by disqualified persons • Spouse and families of any of the above (family in this instance includes ancestors, children, grandchildren, great-grandchildren and their spouses, but not siblings)Taxation of Investments / Page 17
    18. 18. DEBT FINANCED INCOMETaxation of Investments / Page 18
    19. 19. DEBT FINANCED INCOME • Private foundations must include income from debt-financed property in their calculation of unrelated business income. • Debt-financed property is any property that is held to produce income and has acquisition indebtedness at any time during the year. • Any property that is disposed of during the year may be subject to tax if there was acquisition indebtedness with regards to the property at any time during the 12 months prior to the disposal. • Depending on the facts and circumstances, the use of margin accounts in a private foundation’s investment portfolio may cause the organization to be subject to taxation.Taxation of Investments / Page 19
    20. 20. ALTERNATIVE INVESTMENTSTaxation of Investments / Page 20
    21. 21. ALTERNATIVE INVESTMENTS • Activities engaged in by a partnership in which a private foundation is a partner (whether a general or limited partner) is considered to be engaged in directly by the foundation. A foundation needs to pay attention to the activities of such organizations, because the activities can inadvertently cause many problems for the foundation. • A partnership is a disqualified person if more than 35% of the profits interest in the partnership is owned by substantial contributors, foundation mangers, 20% owners, or members of the family of any of these individuals.Taxation of Investments / Page 21
    22. 22. SPENDING POLICY VS. INVESTMENT POLICY Permanent Sustainability vs. Target DateTaxation of Investments / Page 22
    23. 23. SPENDING POLICY VS. INVESTMENT POLICYTaxation of Investments / Page 23
    24. 24. SPENDING POLICY VS. INVESTMENT POLICYTaxation of Investments / Page 24
    25. 25. SPENDING POLICY VS. INVESTMENT POLICYTaxation of Investments / Page 25
    26. 26. FIDUCIARY RESPONSIBILITYTaxation of Investments / Page 26
    27. 27. FIDUCIARY RESPONSIBILITY Prudent Practices for Investment Stewards (The Fiduciary Handbook) Written by Fiduciary 360, 2006; Technical Review by American Institute of Certified Public Accountant; Legal substantiations by Reish, Luftman, Reicher, & Cohen ROLES AND RESPONSIBILITIES OF ALL INVOLVED PARTIES ARE DEFINED, DOCUMENTED, AND ACKNOWLEDGED. • The fiduciary may delegate certain decisions to professional money managers, investment advisors and consultants. But even when decisions have been delegated to a professional, a fiduciary can never fully abdicate these primary responsibilities: – Determining investment goals and objectives – Choosing an appropriate asset allocation strategy – Establishing an explicit, written investment policy consistent with the goals and objectives – Approving appropriate money managers, mutual funds, or other “prudent experts” to implement the investment policy – Monitoring the activities of the overall investment program for compliance with the investment policy – Avoiding conflicts of interest and prohibited transactionsTaxation of Investments / Page 27
    28. 28. FIDUCIARY RESPONSIBILITY “The Handbook was developed specifically for Investment Stewards – trustees, investment committee members, attorneys, accountants, institutional investors, and anyone else involved in managing investment decision-making. The Handbook will serve as a foundation for prudent investment fiduciary practices. It provides investment fiduciaries with an organized process for making informed and consistent decisions.” ~ Excerpt from the AICPA Editorial Statement to Readers APPLICABLE “SAFE HARBOR” PROVISIONS ARE FOLLOWED. • When adopted, liabilities associated with the Investment Steward’s management of the portfolio’s assets may be reduced. If investment decisions are being managed by a committee, there are five generally recognized provisions to the Safe Harbor rules: – Use prudent experts (registered investment adviser, bank, or insurance company) to make the investment decisions. – Demonstrate that the prudent expert was selected by following a due diligence process. – Give the prudent expert discretion over assets. – Have the prudent expert acknowledge their co-fiduciary status. – Monitor the activities of the prudent expert to ensure that the expert is performing the agreed upon tasksTaxation of Investments / Page 28
    29. 29. PORTFOLIO OVERSIGHTTaxation of Investments / Page 29
    30. 30. OVERSIGHTTaxation of Investments / Page 30
    31. 31. OVERSIGHTTaxation of Investments / Page 31
    32. 32. PORTFOLIO OVERSIGHTTaxation of Investments / Page 32
    33. 33. PORTFOLIO OVERSIGHTTaxation of Investments / Page 33
    34. 34. PORTFOLIO OVERSIGHTTaxation of Investments / Page 34
    35. 35. PORTFOLIO OVERSIGHTTaxation of Investments / Page 35
    36. 36. ASSET ALLOCATION: BENCHMARKING DESIGNED TO MATCH THE APPROPRIATE LEVEL OF RISK Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.Taxation of Investments / Page 36
    37. 37. ASSET ALLOCATION VS. MANAGER SELECTIONTaxation of Investments / Page 37
    38. 38. PORTFOLIO OVERSIGHT SUMMARY • Fixed income ̵ Credit quality and maturity matter • Equity ̵ Size and price (style) matter • International ̵ Developed or emerging market matters • Diversified or concentrated • Investors require greater than benchmark performance for assuming greater than benchmark risk. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.Taxation of Investments / Page 38
    39. 39. PORTFOLIO OVERSIGHT APPROPRIATE BENCHMARKS MAY LEAD TO: • Peace of Mind • Accountability • Greater Attention • A more level the playing field • Bottom line improvements Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.Taxation of Investments / Page 39
    40. 40. OTHER CONSIDERATIONSTaxation of Investments / Page 40
    41. 41. INTERNAL REVENUE CODE IRC 4940 EXCISE TAX BASED ON INVESTMENT INCOME. IRC 4941 TAXES ON SELF-DEALING. IRC 4942 TAXES ON FAILURE TO DISTRIBUTE INCOME. IRC 4943 TAXES ON EXCESS BUSINESS HOLDINGS. IRC 4944 TAXES ON INVESTMENTS WHICH JEOPARDIZE CHARITABLE PURPOSE. IRC 4945 TAXES ON TAXABLE EXPENDITURES.Taxation of Investments / Page 41
    42. 42. RESOURCES FORM 990-PF INSTRUCTIONS PUBLICATION 578 WWW.IRS.GOV 20 QUESTIONS PPC DESKBOOK BNA PORTFOLIOSTaxation of Investments / Page 42
    43. 43. Q&ATaxation of Investments / Page 43
    44. 44. THANK YOU!Health Care Reform/ Page 44

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