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IRS §4940
Definition
IRC §4940 imposes an excise tax on the net investment income of private foundations at a rate of 1.39% (reduced from the prior 2% for foundations that meet certain distribution requirements). The tax applies to net investment income including interest, dividends, rents, royalties, and net capital gains. Operating foundations may qualify for a reduced rate or exemption. The tax is paid annually on Form 990-PF and represents a direct cost of investment activity that must be incorporated into portfolio return projections and spending policy analysis.
In the Context of Endowment Management
The §4940 excise tax is a meaningful ongoing expense for foundations with large investment portfolios. For a $200M foundation generating 7% annually, the §4940 tax on investment income can exceed $150,000 per year. Investment policy decisions — including asset location, turnover, and vehicle structure — directly affect the tax liability.