When Incentives Turn into Disincentives

All of us in the nonprofit sector are aware (or, should be aware) that the Foundations who support us have a minimum 5% payout requirement to maintain their nonprofit status. That is, they have promised the IRS that their grants and related expenditures will equal at least 5% of the total value of their assets each tax year.

There are those of us (and if you read this blog regularly, you know I'm one) who consistently call on the foundations to grant out more than the minimum, particularly in years, such as this one, when social need for nonprofit services is high and individual donations are low.

A little less known than the 5% payout, is the excise tax that foundations pay on their investment earnings. Currently, it is generally a 2% tax. However, it is lowered to 1% in any year that a foundation grants out more than their five-year average. This was meant to be an incentive for higher payouts in times of need.

Of course, it is a one-year incentive, since that higher payout raises the five-year average, the tax rate goes back to 2% unless grant amounts continue to rise each year. The return to 2%, according to some in the foundation world, actually then becomes a disincentive to increasing grants in the first place.

According to C. David Campbell, president of the McGregor Fund, a Detroit-based foundation:

"This year, most of the foundations in Detroit will be paying out much more than they have in the past because of the needs... But that will leave all of us in the position of paying more taxes going forward, which ironically will further diminish what we have to support nonprofits."

Enter Senator Charles E. Schumer, New York Democrat, and his buddies, Senators Debbie Stabenow and Carl Levin, Democrats of Michigan. Senator Schumer has proposed eliminating the current two-tiered system with a single excise tax rate of 1.32% in all years.

According to Robert S. Collier, chief executive of the Council of Michigan Foundations

"We are confident this will stimulate more giving by foundations... simply by making the administration of tens of thousands of smaller and midsize foundations much easier because they won’t have to spend a lot of time with their accountants trying to figure out if they have to pay 1 percent or 2 percent."

I'm all for anything that will encourage foundations to do what they're supposed to - support nonprofit organizations - but, really, was figuring out a two-tiered tax system really that much trouble for the foundation world?

And, more to the point, are foundations really saying that the only reason they can't step up and grant out more in this fiscal emergency is because they'll only save on one year's taxes? I know that many foundations are stepping up, and that this does not represent the attitude of the entire sector.

Now, I'm not saying that I'm against Schumer's bill. It's probably a great idea. I'm just saying that certain foundations need to increase their giving in an emergency, excise tax or not.