Private Foundation – Required Annual Minimum Distribution Planning

Authors: Shelley Chen, Partner and Caitlin O’Rourke, Senior Manager
Date Published: February 2026

Key Takeaways:

• Private foundations must meet an annual 5% minimum distribution requirement based on the average fair market value of investment assets under IRC §4942.
• Qualifying distributions extend beyond charitable grants, including certain administrative expenses, direct charitable activities, asset purchases, and program-related investments.
• Strategic planning helps avoid excise tax penalties, leveraging calculation rules and timing flexibility to meet payout requirements efficiently.

Feburary 2026 – Private nonoperating foundations are required under IRC §4942 to make qualifying distributions each year equal to at least 5% of the average fair market value of their endowment in furtherance of their charitable purpose. 

There is a common misconception that only grants made to other charities count towards meeting this requirement. While grants do typically make up the majority of qualifying distributions from most private foundations, it is important to know that many of the foundation’s expenses also qualify. 

What is a Qualifying Distribution (5% Payout)? 

A payment is a “qualifying distribution” if it meets one of the following criteria: 

• Grants or contributions to charities for charitable purposes  
• Reasonable and necessary administrative expenses for the conduct of the charitable activities of the foundation (detailed below) 
• Costs of all direct charitable activities 
• Amount paid to acquire assets used directly in carrying out charitable purposes (such as computers, office furniture or a building) 
• Assets set-aside for charitable purposes (detailed below) 
• Program-related investments and loans (detailed below)

Administrative Expenses 

Administrative expenses, including salaries and benefits, professional fees, travel, training, supplies and overhead, can be classified as qualifying distributions if the expenses are considered reasonable and necessary. 

Judgment may be required in allocating expenses, as any expenses incurred in managing the foundation’s investments are not treated as qualifying distributions. Instead, these costs are deducted against the foundation’s investment income. 

As an example, consider a foundation manager who spends 60% of their time making grants, 20% on selecting and managing investments, and the remaining 20% on foundation administration. In this situation, 80% of the manager’s salary and benefits would be considered a qualifying distribution, while the remaining 20% would be deducted against the foundation’s investment income. 

Generally, the cost of complying with legal, audit and tax requirements and publishing annual reports is also treated as a qualifying distribution. 

Assets Set-Aside for Charitable Purposes 

Assets set-aside for charitable purposes may also be considered for qualifying distributions. However, in practice, set-asides are rarely made because to do so generally requires advance approval from the IRS (Form 8940 with user fee no later than the end of the tax year). The foundation must prove to the IRS that a specific project is better funded over multiple years (generally less than five years) rather than through an immediate payment. A typical example would be the construction of a building, which may take several years from planning to completion. 

If the IRS approves a set-aside, the entire amount of the multi-year grant is treated as a qualifying distribution in year one. Foundations should consult with a tax advisor if they are considering making set-asides because of the complex technical requirements in this area. 

Program-Related Investments 

In addition to making grants, a foundation can also make program-related investments in other charities. Program-related investments often take the form of loans to support charitable activities which meet the foundation’s exempt purpose. 

Amounts distributed in a year for a program-related investment count towards the foundation’s qualifying distribution requirement for that year.  

If a program-related investment is made in the form of a loan, it is important to note that repayment of the loan in a subsequent year will generally increase distributable amounts in the year received. 

How Does a Foundation Compute the Required Distribution? 

In determining the 5% payout, you must first determine the foundation’s “endowment.” This is the monthly average value of the foundation’s investment assets over the tax year. The regulations do not mandate a single valuation methodology. Instead, the foundation must use a reasonable method to determine the average value of its investment assets and apply it consistently from year to year. 

Calculating the Required Distribution 

Once the endowment has been determined, the foundation should make the following calculation: 

Multiply the average asset value (or “endowment”) by 98.5%. This sets aside 1.5% of the assets for an allowed cash reserve 

• Multiply this adjusted endowment by 5% to determine the initial minimum distribution requirement for the year 
• Reduce this amount by qualifying distributions made during the year, including: 
• Assets purchased during the year used in carrying out the charitable purpose 
• Excise tax paid on that year’s net investment income (detailed below) 
• Program-related investments made during the year 
• Increase the remaining distribution requirement amount by any repayment received for previous program-related investments 

The remainder is the distributable amount which must be distributed either through grants or administrative expenses.  

If a foundation qualifying distributions for the year exceed the minimum required, the excess will be carried forward for up to 5 years to help satisfy future payout requirements. 

Excise Tax on Net Investment Income  

Private foundations are subject to a 1.39% excise tax on net investment income. Net investment income generally consists of gross investment income (such as interest, dividends, rents, and royalties) plus net capital gain from the sale or disposition of investment property.   

Investment expenses, such as brokerage fees and allocated salaries, reduce net investment income and thereby reduce the foundation’s excise tax liability. 

When Must the 5% Payout be Completed? 

Private foundations have up to 12 months after a tax year close to satisfy the 5% payout for that year. For example, a private foundation with a tax year ending December 31, 2026 (Year 1) has until December 31, 2027 (Year 2) to complete its required 5% payout requirement for 2026.

What are the Penalties if a Foundation Fails to Meet the Payout Requirement? 

If a private foundation fails to distribute the required amount by the end of the following year, the IRS imposes an excise tax of 30% of the undistributed amount. If the foundation does not correct the shortfall within the allowed correction period, an additional tax of 100% of the remaining undistributed amount may be imposed.  While this penalty is imposed on the foundation, foundation managers should be aware that they could also be charged a penalty by the State Attorney General on the grounds that the manager failed to exercise their fiduciary duty. 

Conclusion 

This provides a broad overview of the annual payout requirements of private foundations. At Frank, Rimerman, our foundation tax, audit, and investment professionals work closely with private foundations to carefully review, plan, and monitor the cash flow and timing requirements to ensure the annual distribution requirements are met. 

About the Authors:


Shelley Chen, Partner
Income Tax Planning and Consulting / LinkedIn / E-mail
Shelley has over 20 years of public accounting experience. Her expertise includes tax planning and compliance for executives and high net worth individuals and their families, including start-up entities and related closely held businesses. She works with a diverse range of clients consisting of a high concentration of investments including real estate holding and development organizations, venture capital and investment enterprises.
 

Caitlin O’Rourke, Senior Manager
Income Tax Planning and Consulting / E-mail
Caitlin O’Rourke is a senior tax manager at Frank, Rimerman + Co. who works primarily with high net worth individuals and their closely held businesses, partnerships, and fiduciary entities. Her experience serving high net worth individuals includes entrepreneurs, real estate investors, philanthropists, and wealth transfer matters. She also has experience in the nonprofit sector, advising both large nonprofit entities and individuals on charitable planning.
 

The material appearing in this communication is for informational purposes only and should not be construed as legal, accounting, tax, or investment advice or opinion provided by Frank, Rimerman + Co. LLP or its subsidiaries or affiliates. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials have been prepared by professionals, the user should not substitute these materials for professional services and should seek advice from an independent advisor before acting on any information presented. Frank, Rimerman + Co. LLP and its subsidiaries or affiliates assume no obligation to provide notification of changes in tax laws or other factors that could affect the information provided.