A foundation generally will qualify for the reduced 1% tax rate if its current year qualifying distributions equal or exceed 1% of its net investment income for the same year, plus an amount determined by multiplying that year’s investment asset average times an historical ratio. The historical ratio is an average of the ratios determined for the five preceding tax years comparing qualifying distributions to relative asset size. If the foundation has been in existence for less than five years, the historical ratio is based upon the number of years the foundation has been in existence.
Qualifying distributions include grants to charities and payments made for administrative, legal and accounting services rendered to a foundation. Such distributions are deemed “qualifying” because they count towards satisfying the foundation’s annual minimum payout requirement. For a private foundation, net investment income is determined by adding gross investment income (e.g., dividends, interest, royalties) to net capital gains and subtracting allowable deductions (e.g., investment management fees).