What Is Federal Form 4720 and Who Must File It?

Form 4720, “Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code,” is a tax form used to report and pay specific excise taxes. These taxes are levied on certain organizations and individuals to discourage activities that could undermine their exempt purposes. The form is most commonly associated with private foundations, which face a set of rules governing their operations and financial activities under Chapter 42 of the Internal Revenue Code.

Who is Required to File Form 4720

A filing requirement for Form 4720 can apply to several parties. The obligation is not limited to the organization itself but extends to individuals who participate in or benefit from prohibited transactions.

The private foundation itself is a primary filer of Form 4720. The foundation is responsible for reporting and paying the initial taxes imposed directly on it for prohibited acts, such as failing to distribute enough income for charitable purposes or making risky investments.

Foundation managers may also have a personal filing obligation. A foundation manager is an officer, director, or trustee of the foundation. These individuals are required to file Form 4720 if they participate in a prohibited act, making them personally liable for an excise tax.

A “disqualified person” is another category of filer and is broadly defined to include individuals and entities with significant influence over the foundation, such as substantial contributors and foundation managers. The definition also extends to the family members of these individuals and any corporations, partnerships, or trusts in which they hold more than a 35% interest. Disqualified persons must file Form 4720 to report and pay excise taxes on transactions of self-dealing.

Other types of organizations may also be required to file Form 4720. These can include donor-advised funds, supporting organizations, and certain public charities that engage in specific taxable activities, such as making excess lobbying expenditures.

Transactions Triggering a Form 4720 Filing

The excise taxes reported on Form 4720 are triggered by specific prohibited transactions detailed in Chapter 42 of the Internal Revenue Code. These rules are designed to prevent the misuse of assets intended for charitable purposes.

Self-Dealing (IRC Section 4941)

Self-dealing involves nearly any financial transaction between a private foundation and a disqualified person. The rules prohibit both direct and indirect interactions, including the sale or leasing of property, lending of money, or furnishing of goods and services. For instance, if a foundation manager’s construction company is hired to renovate the foundation’s office, this would be an act of self-dealing. The payment of compensation to a disqualified person is also self-dealing unless the services are necessary for the foundation’s purpose and the amount is reasonable.

Failure to Distribute Income (IRC Section 4942)

Private foundations are required to distribute a minimum amount for charitable purposes each year. This rule ensures that foundations actively use their funds to support their exempt mission. The required amount is calculated based on the foundation’s “minimum investment return,” which is 5% of the fair market value of its non-charitable assets. If a foundation fails to make sufficient “qualifying distributions” by the end of the following tax year, it is subject to an excise tax on the undistributed income.

Excess Business Holdings (IRC Section 4943)

To prevent foundations from becoming entangled in commercial activities, the law limits their ownership in business enterprises. A private foundation and its disqualified persons are permitted to hold no more than 20% of the voting stock in a corporation or a similar interest in another business entity. If a foundation acquires holdings that exceed this limit, it has a set period, usually five years, to dispose of the excess. Failure to do so triggers an excise tax.

Jeopardy Investments (IRC Section 4944)

A jeopardy investment is one that is so speculative or risky that it jeopardizes the foundation’s ability to carry out its exempt purposes. Foundation managers are expected to exercise ordinary business care and prudence when making investment decisions. While no specific investment is automatically classified as jeopardizing, categories like commodity futures or purchasing securities on margin receive closer scrutiny from the IRS. If an investment is deemed to be a jeopardy investment, both the foundation and any participating foundation managers can be taxed.

Taxable Expenditures (IRC Section 4945)

This rule imposes a tax on certain types of expenditures that are considered inappropriate for a private foundation. These “taxable expenditures” include:

• Amounts paid for lobbying or to influence legislation.
• Funds used to influence the outcome of a public election or to carry on a voter registration drive that is not nonpartisan.
• Grants made to individuals for travel or study, unless they are awarded on an objective basis under a procedure approved in advance by the IRS.
• Grants to organizations that are not public charities, unless the foundation exercises “expenditure responsibility” to ensure the funds are used for their intended purpose.

Information and Calculations for Form 4720

Preparing Form 4720 requires gathering specific information and understanding a two-tiered tax structure. The form is organized into schedules corresponding to each type of prohibited transaction, and a filer must have detailed records to accurately calculate the tax liability.

Required Information

Before beginning the form, a filer must collect key data. This includes the legal name, address, and Taxpayer Identification Number (TIN) for the private foundation and any other parties involved. For each transaction, the filer needs the date of the act, a detailed description of the event, and the “amount involved,” which is a specific term that varies depending on the transaction type.

Understanding the Tax Structure and Correction

The excise taxes on Form 4720 use a two-tier system designed to penalize the prohibited act and encourage its prompt correction. The first-tier tax is an initial penalty imposed when the transaction occurs.

For an act of self-dealing, the tax on the self-dealer is 10% of the amount involved, while a manager who knowingly participates is taxed at 5% (up to $20,000). For failure to distribute income, the tax on the foundation is 30% of the undistributed amount. Excess business holdings are taxed at 10% of their value.

A jeopardizing investment results in a 10% tax on the foundation, and a participating manager faces a separate 10% tax (up to $10,000). For a taxable expenditure, the foundation is taxed at 20% of the amount, while a manager who agrees to it is taxed at 5% (up to $10,000).

If the act is not corrected within a specified period, a much more severe second-tier tax is imposed. Correction is the process of undoing the transaction to restore the foundation to the financial position it would have been in had the act not occurred. Paying the first-tier tax does not eliminate the need for correction.

The second-tier tax on a self-dealer is 200% of the amount involved. For other violations, the tax on the foundation is 100% of the amount for a taxable expenditure or undistributed income, and 200% for uncorrected excess business holdings. Managers who refuse to agree to a correction also face a significant second-tier tax.

Filing the Form and Correcting the Act

Once Form 4720 has been prepared, the final steps involve submitting it to the IRS by the correct deadline and taking action to correct the underlying prohibited transaction. Paying the initial tax does not resolve the issue; correction is a separate step to avoid much larger penalties.

Due Dates

The due date for Form 4720 depends on who is filing. For a private foundation, the form is due by the same date as its annual information return, Form 990-PF, which is the 15th day of the 5th month after its accounting period ends. For an individual filer, the form is due by the 15th day of the 5th month following the end of their personal tax year.

Submission Process

Private foundations must file Form 4720 electronically. Other filers, including individuals, are also required to do so if they file 10 or more returns in total during the calendar year. Any tax due must be paid when the form is filed. Payments can be made through the Electronic Federal Tax Payment System (EFTPS).