Private foundations that file Form 990-PF are subjected to a 4942 tax on the distributable amount if the foundation has undistributed income. The foundations that are not subjected to a 4942 tax on the distributable amount, qualify for a reduced tax of 1% on the net investment income instead of 2% under section 4940(e).
The undistributed income is considered as the distributable amount of the foundation without the qualifying distributions for the tax year. A qualifying distribution is any amount that a foundation uses to carry out a charitable purpose or to buy an asset that is used for a charitable purpose.
For example, X is a private foundation and has allocated $5,000 to spend on charitable purposes. X has spent only $3000 for charitable purposes and the remaining $2000 is undistributed income. X will be subjected to an excise tax of 2% of its investment income if X has undistributed income.
If X spent $5000 completely on charitable purposes, the excise tax based on its investment income for X will be 1% of its investment income.
So, if a foundation has any income from the distributable amount which is not used for charitable purposes, that income is called undistributed income and the foundation will be subjected to a 4942 tax on the distributable amount.
Here's how you can find out your 1% of tax on investment income in Form 990-PF using ExpressTaxExempt:
The 1% tax investment income of your foundation will be automatically calculated once you enter the values.
Note: You do not have to complete this section if your foundation is subjected to a 4942 tax on the distributable amount.