Heard on the Web: Madoff Scandal May Implicate Jeopardizing Investment Tax Rules

Heard on the Web: Madoff Scandal May Implicate Jeopardizing Investment Tax Rules

News story posted in Compliance on 12 February 2009| 3 comments
audience: National Publication | last updated: 18 May 2011


According to an article in the February 11, 2009 issue of the New York Times, private foundations that invested with Bernard Madoff might lose more than their investments. Private foundations and certain charitable trusts (along with their managers/trustees) might be subject to private foundation excise taxes applicable to making jeopardizing investments.

Full Text:

Under IRC section 4944, private foundations and foundation managers are subject to tax on investments that jeopardize the foundation's exempt purpose. In general, an initial tax of ten percent of the amount of the investment applies to the foundation and to foundation managers who participated in the making of the investment knowing that it jeopardized the carrying out of the foundation's exempt purposes. If the investment is not removed from jeopardy (e.g., sold or otherwise disposed of), an additional tax of 25 percent of the amount of the investment is imposed on the foundation and five percent of the amount of the investment on a foundation manager who refused to agree to remove the investment from jeopardy.

According to an article in The New York Times, organizations that invested with Bernard Madoff might be subject to these taxes based on their failure to vet their investments properly, to heed red flags or to diversify prudently.

Although not mentioned in the article, section 4944 does not apply only to private foundations but also to certain charitable trusts. For example, charitable remainder trusts that name a section 170(c) organization as an income recipient are also subject to the jeopardy investment rules. The tax also applies to charitable lead trusts for which the present value of the charitable interest exceeds 60% of the fair market value of the trust's assets on the date of its creation.

For further reading, see

For Investing With Madoff, Private Foundations Could Face Tax Fines The New York Times, February 11, 2009 (requires registration)

Do you think private foundations and charitable trusts (and their trustees) that invested with Madoff should be subject to these taxes? We welcome your comments.

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Madoff Jeopardy Investment

isn't the real issue the failure to diversify, for those charities that put 100% or close to 100% with the same investment manager ? And I don't mean the smaller funds with $5M or $10M, but the larger funds with $50 M or $100M or more. Is it not almost per se imprudent to place such a large sum exclusively in the hands of one investment manager, particularly if how that manager invests is essentially opaque ? Not the failure to vet; not the failure to heed red flags; but the failure to diversify; the latter is the justifiable [perhaps] attack point.

Enough is enough!

Couldn't agree with you more Mark. There are some things that just make your blood boil. As I read the New York Times story, I couldn't help but think of a close friend of mine who has nothing to do with charitable gift planning. Rather, he collects and sells vintage aircraft instruments. If you've ever seen a P-51 Mustang, P-38 Lightning or other numerous warbirds at an airshow, chances are you've seen some of his work. Several years ago, he purchased a large quantity of various WWII aircraft instruments. The dials on many of these instruments were painted with a paint that contained radium, a radioactive element that caused them to glow in the dark so pilots could fly night missions. Well, a short time later, my friend was visited by the EPA. He was accused of violating federal environmental laws even though no such laws prohibiting the possession of such instruments existed. The government then confiscated all the instruments, buried them in the desert, razed the warehouse where they had been stored, and then sent him a clean-up bill for $5 million. The FBI then showed up unannounced at his personal residence to inventory his personal property. What makes my friend's case so ironic is the fact he purchased the instruments from a fellow who purchased them as surplus from, you guessed it, the U.S. Department of Defense. I couldn't help but see the parallel to this story. It has now come to light that a whistle-blower had been complaining to the SEC for the past 10 years about Bernie Madoff, yet nothing was done to stop him. And now, some are speculating that an excise tax on organizations that were the victims of his scheme might be imposed by the same government that failed to nip it in the bud! I'm sure many organizations that invested with Madoff believed they were satisfying their obligation to diversify because that's what they hired Madoff to do. So, in my humble opinion, if the IRS wants to levy an excise tax, it should send the bill to the SEC and then pay a portion of the proceeds to the whistle-blower whose pleas to protect investors fell on deaf ears.


The fact that foundations and split interest trusts may have invested with Madoff is not, in and of itself, enough to create 4944 liability. Any organization with funds of any size should diversify (although in this environment they would only be 50-60% better off that those duped by Bernie); those endowments that put everything on "Black" would be subject to 4944 exposure whether they bet on a winner or loser, but vetting would have nothing to do with that. When the smartest guys in the room, some of whom are in the new administration, were fooled when they vetted Madoff, it seems impossible that foundations doing the same thing could be successfully charged for that alone. Mark B. Weinberg Weinberg & Jacobs, LLP 11300 Rockville Pike Rockville, MD 20852 Voice 301-468-5500 Fax 301-468-5504

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